Balloon payments in commercial lending (ticking time bomb?)
James R. CopelandPro Member
Investor · Port Hueneme, CA · Member since 2017 · 73 posts · 34 votesBalloon payments in commercial lending (ticking time bomb?)
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Alexander FelicePro Member
Guy with Great Hair · Austin, TX · Member since 2013 · 2k+ posts · 4k+ votesIt's not really a ballon as much a liability termination option for the lender.
in 5 years they can call the note due and you refi to another bank. Sometimes they will allow you to refi with them.
Plan to refi, don't plan to pay the debt off in 5 years.
11 Replies
- Rental Property Investor · Maryville, TN · Member since 2009 · 529 posts · 414 votes8y
refinancing those big loans are common practice and usually not a big deal if the payment history has been solid. It is also not uncommon to get 10 year notes on multifamily. Of course tides and environments can change drastically between " re financing" which is causing a lot of concern now, especially for retail
- Real Estate Investor · Burlington, VT · Member since 2010 · 2k+ posts · 1k+ votes8y
@James R. Copeland Keep calling around to other commercial lending departments. I have a few commercial loans and they're fixed for the first 5 years, and then reset with any interest rates changes after, but not a balloon. 20 year amortization for most of mine. I just get a letter in the mail stating the new rate and payment, typically $20 - $25 more per month with the slight rate increases lately.
- Tom
- 8yAlexander FelicePro MemberGuy with Great Hair · Austin, TX · Member since 2013 · 2k+ posts · 4k+ votes
It's not really a ballon as much a liability termination option for the lender.
in 5 years they can call the note due and you refi to another bank. Sometimes they will allow you to refi with them.
Plan to refi, don't plan to pay the debt off in 5 years.
- Specialist · North Kansas City, MO · Member since 2015 · 17 posts · 6 votes8y
It all comes down to your lender and the commercial real estate financial markets as a whole, and what the capacity for lending looks like when it comes time to refinance. A result of the 2007/2008 crisis was that lenders were unable to sell their loans and move them off their balance sheets as quickly as they had been able to before and so they stopped bring more debt onto their balance sheets (meaning they stopped lending).. and it became harder to obtain refinancing. When the Borrower was unable to repay their loan at maturity than the lender is either going to take your property, you are going to give up your property, or you both will agree to new terms in order to keep everything going if that is in the best interest of your lender.
You are an investor. There are risks and rewards. Make sure that your due dilligence outlines all potential risks, and that your management systems focus on managing those risks and ensuring the quickest re-coop of your investment and a return. There is more to Commercial Real Estate than just economics and physical property. The financial markets are important to understand.
- Massillon, OH · Member since 2014 · 9 posts · 2 votes8y
We have typically just renewed with same bank, rate adjust and small fee. The balloon in commercial not as big of a concern if solid property. If sitting on vacancy, that would be another discussion.
- Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes8y
It is a valid concern. I had a 5/5/20 with a local bank. During the GRC they about terminated/called my loan, but my 5 yr reset and review was about 6 months before they completely 'lost their appetite for commercial assets in this uncertain regulatory environment.'
Or the committee could have just decided - no. Or they could have had a bad quarter. I've paid all mine off and will never borrow commercial money from an institution again, personally.
They don't tend to act as islands. If one starts deciding to call, the rest will soon follow. I'll be there waiting :)
- 8yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
@Steve Vaughan lots of factors for the commercial banks.. regulators might have told them to reduce exposure to real estate.. so there goes your refi.. bank could have failed.. ( this happened big time) in GA 450 small banks failed in the GFC big player buys all the loans for pennies on the dollar and you are not getting any love from them pay them off or they foreclose.. saw that more than once.. regardless of what the asset was or was doing.
but lets remember 08 to 2010 hopefully was a once in an investor life time situation... but it can happen. your smart to limit your exposure to those types of loans.. I have only one myself.. and will not get any more like that..
- Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes8yJames R. Copeland In *most* cases you can just (as others have said) keep refinancing __ months before the balloon is due. The interest rate resets to “market” and maybe there’s a fee, new appraisal, etc. However, if variables change: income, net worth, performance of the property, DTE of the property if values drop, etc. I wouldn’t be so sure. I have no idea if that local/region bank would think “Who cares? They pay like clockwork!” or if their loan committee would (essentially) start from scratch. Odds are it would really depend on the bank.
- Golden, CO · Member since 2016 · 145 posts · 61 votes8y
Your concern regarding refinance risk is very valid. Our economy is very cyclical and many investors have already forgotten our economy is generally on 8 to 10 year cycles. This recovery is getting very long-in-the-tooth and with so many segments of our economy overheated, there is a very good chance of an adjustment.
During the last crisis I worked for the FDIC closing and resolving failed banks. Regrettably, I see many of the same things we saw prior to the crisis. We have never been in an environment where interest rates have been so low for so long. I have friends in the loan workout industry that are already running models to anticipate what the next market adjustment will look like.
So how do you avoid refinance or refinance-risks cousin, default risk? You try and structure deals with longer terms and possibly no balloon payments. It is naive to think that just because you have made all of your payments that your current lender will simply continue to re-extend your note, regardless of what your current loan officer tells you. You can also try and structure the deal without any personal recourse or limited personal recourse. Structures without personal recourse can be tough and you may sacrifice yield by putting down a large down payment but there are lenders who are so hungry for deals that you may be able to limit your personal exposure if something were to go wrong. Many borrowers simply don't know to ask.
Ultimately, there are a number of factors out of your control. Your "credit" tenant may file for bankruptcy or a tenant may use some minor clause to cancel their lease or drag you to court to void a lease. There are risks so you should make sure you are rewarded in any deal with proper upside.
And one more thing to keep in mind if "it" hits the fan. Find someone like me who has worked billions of dollars in defaulted loans and I can negotiate some amazing terms if the economy tanks. When the chips are down I have seen methods such as discounted payoffs, deeds in lieu, etc work very well but you have to be educated.
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes8y
My clients when buying retail we stress test the debt. So if buying at a 7 cap and debt starts at 4.5 fixed with 25 year amortization what will loan balance be with regular payments in 5 to 7 years and what will blended cap rate be up to conservatively by then?
I am not a fan of 3 to 5 year debt unless it's a value add play with no pre-pay penalty. You increase the cap so even at an interest rate increase with a higher cap rate the DSCR ratio is generally maintained.
I also do not like 5/5 loans where it's fixed for 5 years then goes to MARKET for 5 years. In 5 years that rate could be 6,7,8???
Instead you can do a blend loan where it's for 10 years for example fixed at 4.7 with a 25 year amortization and then the next 5 years it goes to market BUT there is a ceiling of 6 percent. Meaning year 6 if interest rates are 7 or 8 they still have to give you 6 for years 6 to 10. This way you can model out the income and debt.
Cycles as mentioned go about every 8 to 10 years so I like commercial debt that is the same amount of time as a cycle. This way you generally can refi or sell and 1031 at the time you want that is optimal versus a short term loan where you are forced to sell or refi on terms in the market you do not necessarily desire.
- midwest · Member since 2016 · 25 posts · 17 votes8y
I'm an outlier, I guess, but I don't like balloon payment loans, at all.
I've had commercial RE since '04, and I have never had a balloon except for our very first commercial loan, which we refi'ed out of as soon as possible -- within 2 years -- into a fixed rate, fixed term loan with no balloon. We refi'ed it again a few years later for better terms, and, again, we refused to consider any options that included a balloon. Once I was out of the first balloon, I adamantly refused to consider any balloon loans, ever again.
Our approach was/is that the only reason for accepting a balloon is if that's the only way to get the loan and we desperately want/need it. IIRC, our initial balloon was in 7 years, but I worked on refi'ing to get out of the ballon pretty much as soon as our business was sufficiently established to have a chance of convincing a bank to get us a better loan. And, once we were out of the ballon, I was never willing to consider one again, ever, period.
Talk to folks who had balloons coming due during the 07/08 crisis . . . and you might be extra wary of balloons. A close family member of mine came close to losing a million+ commercial property (and its multimillion dollar business that resided on that property) with less than a third the value of the property in a mortgage because the timing was so bad for when her balloon came due during the crisis. She'd had that property for decades, and it was the cornerstone of her business . . . She managed to refi but was *totally* hosed on terms/fees -- like catastrophically hosed. It was incredibly scary.
My understanding is that commercial loans offer VERY few protections to the borrower. If the balloon comes due and you can't refi or pay it off in cash, you can be out of luck very quickly. That's just not comfortable for me . . . Besides, my goal is to gain net worth via paying off debts/mortgages, so I just aim for fixed term mortgages that can be paid off via rents . . . I don't want the endless cycle of balloon mortgages that seem designed to benefit banks, not borrowers.
FWIW, I've found that I've (nearly) always been able to get non-balloon loans so long as I call around and refuse to consider balloons, period . . . Many banks won't do terms longer than 5-7 years on commercial loans, which is why (I think) there are so many balloons . . . But, I've had excellent, very low fixed rate commercial mortgages for up to 15 year terms. I do know that things got a lot tighter in the last 10 years in that regard, so I can't guarantee (good) fixed rate for that many years are still possible. The last time we refi'ed our commercial RE mortgage was around 4 years ago, and at that time, I think we were looking at about a 9-10 year time horizon on our payoff (and didn't change it, just reduced interest rate and/or took out cash). Then a couple years later, I recall other banks (and maybe even the original lending bank) looking at that mortgage with wide eyes and telling me they can not do fixed rate commercial mortgages for that long any more . . . Just can't do them and couldn't touch the deal we already had. So, anyway, it pays to shop around a LOT. (As is always the case with loans, in my experience.)
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