Floating Rate vs Fixed Rate Debt

[Todd Dexheimer]

I'm a firm believer that floating bridge debt (even with rate caps), should never be used on deals that are 90%+ occupied.

Bridge Debt is an ok tool for distressed deals that a local bank won't touch, but only with the right structure in place. If you have to go bridge debt on the rare occasion, be sure that the LTV remains low (65% or less), keep 12+ months of debt service liquid, have a frothy renovation budget, buy a 3-year in-the-money rate cap, have reserves for a future rate If it's 90% occupied, then use Fannie, Freddie, CMBS, or bank debt

If it's under 90%, try to get fixed-rate CMBS or bank debt. Local banks often have great debt tools. Sure you sign a personal guarantee, but we have found excellent 5-year fixed renovation loans with our banking partners.

If it's a screaming good deal and for some reason a bank won't finance it, then consider bridge debt with a rate cap, with low leverage (65% or less).

Stop using it for a bread-and-butter value add. If you're an investor, ask the sponsor why they're using bridge debt. Some sponsors use it on every deal because it's cheaper or provides them with flexibility. I call BS. I've run the analysis and a fixed-rate agency loan with a step-down pre-payment is still cheaper than a bridge loan if you hold for more than 2 years. Plus, the fixed provides you with way less risk.

Let me hear your thoughts. Why is it ok to use floating bridge debt on a 90% occupied value-add deal?

[Mark Kenney]

@Todd Dexheimer

I agree 100%.

One reason someone might choose Bridge is if a property is already 90%+ occupied but still has a large CapEx plan. Agency lenders typically provide little to no CapEx funding, while Bridge lenders often fund 100% of the CapEx budget. However, reimbursement requests can be frustrating and much harder than expected with some lenders.

If you plan to hold a property short term, Bridge is usually the better option. That said, many investors got stuck in deals they couldn’t sell for enough to cover the loan, while refinancing required significant additional capital.

Bridge loans also usually have much smaller prepayment penalties. With agency and CMBS loans, those penalties can be enormous. So, you need to understand the differences between Step-Down, Yield Maintenance, and Defeasance. Step-Down has a known pre-pay. Yield Maintenance and Defeasance are not a fixed pre-pay. And, even a Step-Down can be very high...HUD is typically a 10% pre-pay and goes down 1% per year.

I sold a deal back in 2022 and the loan balance was $8.2M and my pre-payment penalty on a Fannie loan was $2.4M. If this had been Bridge, my pre-payment would have typically been much smaller.

Rate caps can help protect you on Floating Rate, but in the past they increased more than 3,400% in less than two years. When borrowers had to renew them, it often required substantial additional capital.

Bank debt can work too, but remember it will likely be full recourse.

There are many options available and if you are newer, you won't even know how to evaluate your options. I have a 35 column Excel that has everything I look for when evaluating loan types.

Overall...

I have burned enough with floating rate. I am mostly only interested in Fixed, Long-term, with a KNOWN Pre-Payment Penalty.