Scenario:
- Fully stabilized retail center. "Shadow-anchored," meaning the Target or Costco building isn't included with the purchase, but it shares a parking lot or similar. In other words the subject property owner's tenants benefit from that property that subject property's owner does not own (and thus pay more in rent, vacancies will be easier to fill, etc). The mortgage terms might be a little better if the buyer got the big sexy national tenant with 17 years left on a NNN lease, but that's not our scenario.
- 6% cap rate reflects a nice safe part of Los Angeles, California, a prudent investment, not one that will make anyone rich overnight, but a place that higher net worth individuals park wealth to preserve it (imagine the depreciation write-off). 6% cap rate also tells us, right off the bat, that we're going to be in the ballpark of 60% LTV.
- We will stipulate that this is hypothetical.
Survey of mortgage terms (click to enlarge):
From left to right, 1.25 points, 1.5 points, 1 point but $41k in fees.
Prepayment penalty: 5 years declining, none, 2 year lockout followed by 10 years defeasance.
Commentary/review/discussion:
I tried to provide three very different options here, but all still real ways that people actually acquire such assets. We've got a national bank, a local credit union, and a direct-to commercial mortgage backed security. With a 6% cap rate, this will be DSCR-constrained. When I see that 60% LTV will not work, rather than jumping to 55% LTV, I walk it down - 59, 58, etc, as you can see. The interest rates are competitive across the board, it's not going to come down to that for most buyers.
National Bank: This is the 'standard,' the 'baseline,' what most people do. 5 year prepayment penalty is slightly unfortunate, as many pontificators say rates will be dropping "soon," and it may make refinancing a little more painful. This bank requires the borrower be local to the subject property, so your Bay Area tech wizard or Texas oiligarch (see what I did there?) wouldn't be able to get this mortgage unless they lived in SoCal and worked remote. Given how good the terms are, I'm surprised to read that they will work with someone that had a bankruptcy or foreclosure more than 3 years ago with a sufficiently compelling letter of explanation along with supporting documentation.
Credit Union: Fixed for 10 years, 30 year amortization AND no prepayment penalty? That's enticing. Subject property and borrower must be local to the CU, SoCal people only once again, in this case. No cannabis tenants is specifically noted. Compared to the previous option, you have to put 1% more towards the down payment and pay another 0.25 in points. I think between the last option and this one, most folks would pay the 1% + 0.25% for the lack of PPP.
Commercial Mortgage Backed Security: Net worth must be equal to the loan amount, and liquidity must be 10% of the loan amount, absentee borrower is fine/normal here. Here's your oddball of the group, the deal size here is right around the size where CMBS become viable. That $40k to $50k in fees is the same if it's a $2m loan or a $20m loan, in this case $41k / $2.36m is the same as 1.7 points (but would be 0.2 points on a $20m loan, you can see why it's enticing for the bigger loans). I actually wouldn't advise this option for a loan this small when the other 2 options are so compelling, but it popped up and is interesting to talk about. The 2 year lockout period means that they will not accept additional payments beyond the minimum payment (trade-off is that sometimes you can get them to go for interest only). The prepayment penalty is defeasance, if rates are the same or go down that is the most severe PPP that exists. Here's a blog post about it. TLDR: If you're in year 4 of 10 and pay the mortgage off, your payoff balance will be adjusted to reflect the cost of buying a gov't bond that will produce the equivalent amount of dividend payments for the remaining 6 years (in other words, one way or another, the lender is absolutely going to get their 10 years of payments). If rates drop, that means your payoff balance could be vastly higher than your actual loan balance. These mortgages can be assumed, however, and are non-recourse (if your name is a musical instrument and you were a reality TV star, and made cameo appearances in WWF, this might be the type of mortgage you get for some of your projects, which might ahem wind up being front page CNN news).
