Underwriting with refi

[Jason Rosenblum]

Hi all,

What is the accepted approach with respect to underwriting to forecast a refinance on a multi family property. What interest rate should be assumed and on what basis.

Thanks!

[David Almeida]

The prudent approach is to assume some slight increase in interest rates-- usually 5 to 10 bps per year. But with the Fed's monetary policy these days, they might go lower before they go higher. 

Regardless, it's also prudent to assuming the new loan will be the lesser of three values (or two if it's a smaller- to mid-sized multi) based on: (1) Loan-to-Value % (LTV), (2) Debt Service Coverage Ratio (DSCR), or (3) Debt Yield (DY). The first two are the most common.

Let's say you plan on refinancing in year 4 of your proforma. You'll take the trailing-12-month Net Operating Income (NOI) and calculate the property's market value using an assumed cap rate. For example, a $100,000 NOI with a 10cap would be a value of $1,000,000.

Apply the loan-to-value % (LTV) to get your first market value. Let's assume 80%, so that's a loan of $800,000.

Next, let's assume the bank requires a 1.20 DSCR. Divide the NOI of $100,000 by 1.20 and you'll get $83,333.33. This is the maximum annual debt payment the property will support. You can then take that number and use a financial calculation to get the Present Value assuming the new loan's interest rate and amortization period. This will give you the second loan. (In this case, I assume a 5% interest rate and 30-year amortization and got a loan of $1,281,038).

Finally, the Debt Yield (DY) is simply the NOI divided by the debt amount. So if the bank says they have a minimum debt yield of 8%, you'll get a maximum loan of $1,250,000.

So the minimum of these three is the LTV approach of $800,000. Now this example isn't perfect because I used a 10cap at the start, but hopefully you get the idea.

At this point, you'll be paying off the balance of your acquisition loan with the new loan and will need to pay the up front fees for the new loan in cash, so don't forget those. The difference will be the cash-out.