How are increased reserve requirements affecting returns?

Question

With the new reserve requirements of 12-18 months for Fannie/Freddie loans, how is this affecting your projected returns? That's a lot of capital you have to account for that's not getting a return.

Can you plan to return that capital to after some period of time, or do the agencies require it to remain in place for the life of the loan?

Brian Burke · Answer

It won't affect my projected returns at all, but it will affect the actual returns of sellers.  Since all I'm doing is solving for a return when calculating my strike price, the added reserve requirements just mean that I'll end up solving to a lower price in order to project the same return as I otherwise would have projected at a higher price without the added reserves.

Evan Polaski · Answer

@Ryan Daigle I was just on the phone with lender this morning.  Technically, these reserves are not life of the loan, unless you feel there will be government "lifestyle" restrictions for the long haul.

As of this morning, reserves will be returned to borrower 3 months after government stops any restrictions with occupancy, NOI and DSCR ratios at or better than acquisition.

Mary M. · Answer

This is exactly what is happening with a deal I am working on....

Charles Carillo · Answer

@Ryan Daigle

I was discussing this same question with my partners weeks back and our thinking was yes this will lower returns to investors but if there possibly is an increase in cap rates (due to uncertainty) in the next several months (along with a decrease in lending rates to under 3%) it might not affect returns that much. We were borrowing money in the low to mid 4s last year and if you cut your interest by 25%-30%; that  is going to make a huge difference.

https://www.inman.com/2020/04/...

Ryan Daigle · Answer

@Mary Mitchell nice recovery. Good luck with the acquisition!

Mary M. · Answer

@Ryan Daigle we dropped out of contract several weeks ago (for reasons unrelated to financing) but were able to renegotiate new terms given the lending environment which allowed us to get the deal on track again.

Ryan Daigle · Answer

@Evan Polaski great info, thank you! So nobody knows exactly what date the reserves will be returned, but at least we know the logic behind releasing those funds and can model it in.

Ryan Daigle · Answer

@Mary Mitchell was the property already under contract and are you having to renegotiate?

Ryan Daigle · Answer

Agreed - so this factor alone seems to indicate that cap rates on the larger assets _has_ to go up unless the further decrease in interest rates is enough to bridge the gap or investors are willing to take lower returns in this environment.

Charles Seaman · Answer

@Ryan Daigle  The only way to account for it is by acquiring the property at a lower purchase price.  Otherwise, your returns will be negatively impacted because of the additional capital that needs to be raised.

How are increased reserve requirements affecting returns?

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