How much is to much levarage in a syndication structure ?

Question

Should GP’s use less leverage than normal because covi-19?

How much is normal in the new normal compared with pre/covi?

Brian Burke · Answer

More leverage means more risk, and vice versa.  In the face of uncertainty, or worse, in the face of an outright recession, I'd rather reduce my risk as much as possible because outside forces will add enough risk without me adding more via heavy borrowing.  We are sticking to 75% of cost as a maximum, with 75% of purchase price being a soft target and 70% being even more likely.  We are seeing a lot of deals right now where the income doesn't support anything higher than the mid 60's to maintain coverage constraints.

Greg Dickerson · Answer

Banks are requiring more equity so GP has little choice right now. It's dependent upon the sponsor, asset, market, timing etc. It's week to week and deal to deal right now.

Bryan Hancock · Answer

Leverage is like speed.  If you are super skillful and know how to race indy cars you can get where you want to go faster with more leverage, but you can also crash and burn if you're not skillful.  Far too many sponsors make the mistake thinking that they're more skillful than they are and end up in a giant ball of flames.

Having said that I'd like to take the contrarian view and say now is the time for MORE leverage if you're positioned properly.  The time to buy is when there is blood in the streets, but you need to be positioned properly to do so.  Few people are positioned to take advantage of the blood in the streets so most people are well-served to be conservative right now.  The question is how do you position yourself to take advantage of the market?

Danny Randazzo · Answer

@Eduardo Calle a key stat to look at is the break even occupancy. What occupancy do you need to have to pay all expenses plus debt service. This will give you an indication of the conservative nature of the cash flows at the property. For example, if you need 90% occupancy to pay expenses and debt service then Covid vacancy or non paying tenants could be an issue. If you need 50-60% occupancy then you should be ok if your property historically has strong occupancy and collections.

Jordan Burnett · Answer

Personally I would be hesitant to invest in anything over 70% LTV at the moment, and that's also taking the going-in cap rate into consideration. I saw deals anywhere from 75-80+% LTV prior to the COVID-19 pandemic.

The agencies are being conservative and trying to avoid getting burned, but I would not be shocked to see sponsors coming out with low 4 or high 3 cap rates and 75+% LTV in the next few months to try and squeeze a deal in. This would likely be with bridge loans and not agency debt.

Todd Dexheimer · Answer

I would be looking more closely at debt service coverage ratio. I want to see 1.4 or higher on all deals. This allow for some wiggle room in case we hit bad times. This could be 75%, but may also have to be 60% LTV

Steve Morris · Answer

"How much is too much leverage in a syndication structure ?"

Well, I don't think being a syndication means much, but you need to have enough CFBT to pay for emergencies and avoid having to feed (aka capital call in syndication) if you run into an issue with the property.  You also need to meet the lenders DSCR.

CFBT = Income - Expense - Debt  and Cash-Cash = CFBT/Down - You have XLS and easy to figure out.

Another way to do quick check is some sort of acid test = (Expenses+Debt)/Income.  The lower the better.  If (for example) that number is 80%, you could roughly lose 20% of your income and still be floating.

John Casmon · Answer

To be over-leveraged is to be in a position where you can't cover the bills or can't refinance into a new loan. So consider the breakeven occupancy as @Danny Randazzo mentioned, the rest of the loan terms, business plan, and the hold period.

Say you are getting a 2-year bridge loan with 80% LTV and interest-only payments. You should be very cautious about the amount of leverage that is used as you HAVE to refinance at the end of 2 years. However, say you are getting a 35-year HUD loan with 85% LTV and no interest-only period. You don't need to refinance and will be paying the principal down right away. As long as you can cover your bills you should be fine. Now, the exit may be more of a challenge, but you may not be as concerned with the amount of leverage.

Danny Randazzo · Answer

@Eduardo Calle each deal is different so it depends per each deal the amount of leverage. If you are comfortable with the deal, understand the numbers and risks then getting max leverage may be fine for your deal.

Austin Sine · Answer

@Eduardo Calle

Echo everything above. @danny randazzo mentioned this already but I really like to use breakeven occupancy. I would also stress test. Run the deal on a worst case scenario. What happens if things get rocky and you can’t increase rents for a few years, capex comes 20% over budget (which it will), taxes increase, R&M is 20% over the years prior? If the deal still breaks even at w/e leverage you decide than you can feel at least more comfortable with the deal. Also don’t forget reserves!

I’m keeping my eye on 80% LTV deals as the year progresses.

How much is to much levarage in a syndication structure ?

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