On the topic of mortgages I’m interest in what happens when I have to renew my commercial mortgage. Let’s say I have a cap rate of 7% and I’m borrowing at 4.5% 10 year fixed rate with 25% LTV at the onset (assume amortization of 30 years). Let’s say in 10 years we are in a very different rate environment and mortgage rates are 7.5%. Now I’m no longer 25% LTV but the math still isn’t great for myself or for my renter (let’s assume this is a single tenant triple net leased building for simplicity). Was I raising rent all along in conjunction with interest rate increases and do I try to align the lease renewal options with my mortgage renewal period?
Just trying to figure out how this process works. Would love to dive into some online reading on this.
Thanks for the feedback. My project is in its early stages and I am trying to come up with a budget. The bank that I have been in touch with says they can do 85% LTV but may have a 7yr reset. I am fairly unfamiliar with the commercial mortgage landscape and trying to explore possible options. At 15% a 3m project requires 450k down payment vs 750k for a 5m project. I am building up that down payment and the available options and timeline may determine the project scope.
Well your scenario probably isn’t the best hypothetical. Typically on a 7 cap STNL property, there is likely plenty of term remaining on the base term and several renewal options with predetermined rates. The rental rate and increases are likely already laid out in the lease terms for the foreseeable future. That’s why you pay such a premium for those properties; they have long term predictable cash flows backed by strong credit worthy tenants. So the answer to the first part of the bolded above is no. The rent was increasing (or perhaps staying flat) per whatever the lease stated, not based on whatever you want to charge them. As for the second part, the answer is also no. The last thing you want to have happen is be staring down the barrel of a significant rate increase and potentially having a vacant building.
The reality is that if you’re using anything but fixed rate financing, you need to be proactively managing your debt service. You should never find yourself in the scenario you described. You typically won’t see people get to the balloon on their debt. Hypothetically if you had a 10/20 loan on your property, you should be refinancing that long before you get to the ten year balloon (like 5-7 years in). That way you’re rolling your balloon out another 5 – 7 years. This is especially true in a rising interest rate environment. In your scenario, you would have known for years that you were going to be facing a higher interest rate and you should have refinanced, rolled the balloon out (or moved to a fixed product), and taken a small interest rate hike rather than wait til the very end and have to eat a 3% rate hike. There are a lot of variables and other things to keep in mind (how much term is left on the lease with your tenant which will have a big impact on your ability to refinance for example).
If for some reason you did end up in a scenario like the one you described, you wouldn’t be totally screwed though. You would have paid down significant principal on your loan (commercial loans are rarely 30 years, predominately they’re 20 year ams). You could refinance the remaining principal into a new loan which would significantly reduce your debt service despite the rate increase, and you’d also presumably have some rental increases in the lease to help offset it further.
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