Mortgage Options for commercial realestate

[Dont_know_mind]

HumbleInvestor wrote:

Dont_know_mind wrote:

HumbleInvestor wrote:

@dont_know_mind, Thank you for your detailed response. The land is roughly 1.2m and I have $850k saved so far. It is in a good location but I have not done the feasibility study (wetlands with 20% build-able area) or detailed cost analysis. Speaking to another building owner who built in the last couple of years, I gathered that the total project for a 15k sqft building might cost around 5M including the land. My current debt is a home mortgage of $360K at 4% and my cash position is about 60% of my liquid assets (taxable account, retirements etc) as I have been focused on retiring practice debt for the last few years. If the practice income remains stable I should have about 400k a year to put in to investments/debt servicing etc. Moving my practice to a bigger, visible and accessible location will improve our growth as we are growing out of our current space. In the short term, the building will allow my practice to grow while accumulating equity as I intend to have co-tenants. I understand there are easy ways beyond owning real-estate but instead of spending approximately 1.5m in rent over the next 20 years, I can potentially own 10 times bigger space for 3 times that amount and have something to show for at the end of it.

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So what is your current asset allocation : stocks/real estate/cash ?

I was tempted to undertake what you describe last year but more for a 1-2M property with 1M build.

I would think of hedging your land value and doing the build by steps. I would think about first buying suitable land, then build to your current size with capacity to expand when required. Building the whole thing is lumpy and more risky.

I could be completely wrong so I would not put any value on this, but my current expectation is that the cycle goes until 2021 in terms of date of next recession. So it is a really hard time to know how to allocate in terms of leverage currently. No right or wrong or crystal ball that is at all accurate. But 10 years into a cycle, you have to be prepared for a recession at some stage.

I am curious about the land – if it is desirable, why is on on the market still ? That would be unusual for it to be on market for years and be desirable. Also you must check with local authorities that you will be able to build healthcare facilities on it. What is the land area and buildable area ?

Also structuring, this is painful but if you can sort out the optimal structuring before you buy the land, it will save headaches and tax later.

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60% cash, 25% taxable account and 15% retirement account. Own the business free and clear and the only debt is $360k mortgage on a house probably valued around 900k.

The land is available for sale but is not actively marketed currently. It was on the market few years ago for 800K and then taken off the market. Recent inquiries came back with 1.2m price tag. About 5 acre wetland property but only 0.5 to 0.75 acres of buildable area. City is ready to approve healthcare/office building but requires roadside improvements etc which are expected to cost 400-500k. So the cost of any potential project is high for such a small buildable area, thereby reducing the attractiveness of the property. However it is in a prime area and a 15k sqft building should be feasible for around 5M, and 100% occupancy can generate 600k in gross rents at current market rates.

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600k gross yield at 100% occupancy on 5M build does not sound that attractive to me. Particularly with unknowns from build cost blowout potentially and other problems that can emerge including local government approval potholes.

You might be better off buying a 1 acre block for the same price without the improvement requirements.

The critical question for me would be: will the land appreciate? If it will the large build may not really be necessary or add that much to long term return. I would tend to build what I need to use and to make carrying costs of the land easier. But actually, I have gone beyond that and now am happy just to buy the land and do nothing.

I really know nothing about building and try to do minimal.

Another thing that you could do if you are keen on the land is to buy an option on it for 1 year whilst you get local government approvals finalized.

[HumbleInvestor]

Dont_know_mind wrote:

HumbleInvestor wrote:

@dont_know_mind, Thank you for your detailed response. The land is roughly 1.2m and I have $850k saved so far. It is in a good location but I have not done the feasibility study (wetlands with 20% build-able area) or detailed cost analysis. Speaking to another building owner who built in the last couple of years, I gathered that the total project for a 15k sqft building might cost around 5M including the land. My current debt is a home mortgage of $360K at 4% and my cash position is about 60% of my liquid assets (taxable account, retirements etc) as I have been focused on retiring practice debt for the last few years. If the practice income remains stable I should have about 400k a year to put in to investments/debt servicing etc. Moving my practice to a bigger, visible and accessible location will improve our growth as we are growing out of our current space. In the short term, the building will allow my practice to grow while accumulating equity as I intend to have co-tenants. I understand there are easy ways beyond owning real-estate but instead of spending approximately 1.5m in rent over the next 20 years, I can potentially own 10 times bigger space for 3 times that amount and have something to show for at the end of it.

Click to expand…

So what is your current asset allocation : stocks/real estate/cash ?

I was tempted to undertake what you describe last year but more for a 1-2M property with 1M build.

I would think of hedging your land value and doing the build by steps. I would think about first buying suitable land, then build to your current size with capacity to expand when required. Building the whole thing is lumpy and more risky.

I could be completely wrong so I would not put any value on this, but my current expectation is that the cycle goes until 2021 in terms of date of next recession. So it is a really hard time to know how to allocate in terms of leverage currently. No right or wrong or crystal ball that is at all accurate. But 10 years into a cycle, you have to be prepared for a recession at some stage.

I am curious about the land – if it is desirable, why is on on the market still ? That would be unusual for it to be on market for years and be desirable. Also you must check with local authorities that you will be able to build healthcare facilities on it. What is the land area and buildable area ?

Also structuring, this is painful but if you can sort out the optimal structuring before you buy the land, it will save headaches and tax later.

Click to expand...

60% cash, 25% taxable account and 15% retirement account. Own the business free and clear and the only debt is $360k mortgage on a house probably valued around 900k.

The land is available for sale but is not actively marketed currently. It was on the market few years ago for 800K and then taken off the market. Recent inquiries came back with 1.2m price tag. About 5 acre wetland property but only 0.5 to 0.75 acres of buildable area. City is ready to approve healthcare/office building but requires roadside improvements etc which are expected to cost 400-500k. So the cost of any potential project is high for such a small buildable area, thereby reducing the attractiveness of the property. However it is in a prime area and a 15k sqft building should be feasible for around 5M, and 100% occupancy can generate 600k in gross rents at current market rates.

[Dont_know_mind]

HumbleInvestor wrote:

@dont_know_mind, Thank you for your detailed response. The land is roughly 1.2m and I have $850k saved so far. It is in a good location but I have not done the feasibility study (wetlands with 20% build-able area) or detailed cost analysis. Speaking to another building owner who built in the last couple of years, I gathered that the total project for a 15k sqft building might cost around 5M including the land. My current debt is a home mortgage of $360K at 4% and my cash position is about 60% of my liquid assets (taxable account, retirements etc) as I have been focused on retiring practice debt for the last few years. If the practice income remains stable I should have about 400k a year to put in to investments/debt servicing etc. Moving my practice to a bigger, visible and accessible location will improve our growth as we are growing out of our current space. In the short term, the building will allow my practice to grow while accumulating equity as I intend to have co-tenants. I understand there are easy ways beyond owning real-estate but instead of spending approximately 1.5m in rent over the next 20 years, I can potentially own 10 times bigger space for 3 times that amount and have something to show for at the end of it.

Click to expand...

So what is your current asset allocation : stocks/real estate/cash ?

I was tempted to undertake what you describe last year but more for a 1-2M property with 1M build.

I would think of hedging your land value and doing the build by steps. I would think about first buying suitable land, then build to your current size with capacity to expand when required. Building the whole thing is lumpy and more risky.

I could be completely wrong so I would not put any value on this, but my current expectation is that the cycle goes until 2021 in terms of date of next recession. So it is a really hard time to know how to allocate in terms of leverage currently. No right or wrong or crystal ball that is at all accurate. But 10 years into a cycle, you have to be prepared for a recession at some stage.

I am curious about the land - if it is desirable, why is on on the market still ? That would be unusual for it to be on market for years and be desirable. Also you must check with local authorities that you will be able to build healthcare facilities on it. What is the land area and buildable area ?

Also structuring, this is painful but if you can sort out the optimal structuring before you buy the land, it will save headaches and tax later.

[HumbleInvestor]

@Dont_know_mind, Thank you for your detailed response. The land is roughly 1.2m and I have $850k saved so far. It is in a good location but I have not done the feasibility study (wetlands with 20% build-able area) or detailed cost analysis. Speaking to another building owner who built in the last couple of years, I gathered that the total project for a 15k sqft building might cost around 5M including the land. My current debt is a home mortgage of $360K at 4% and my cash position is about 60% of my liquid assets (taxable account, retirements etc) as I have been focused on retiring practice debt for the last few years. If the practice income remains stable I should have about 400k a year to put in to investments/debt servicing etc. Moving my practice to a bigger, visible and accessible location will improve our growth as we are growing out of our current space. In the short term, the building will allow my practice to grow while accumulating equity as I intend to have co-tenants. I understand there are easy ways beyond owning real-estate but instead of spending approximately 1.5m in rent over the next 20 years, I can potentially own 10 times bigger space for 3 times that amount and have something to show for at the end of it.

[Dont_know_mind]

HumbleInvestor wrote:

Thank you for the feedback. I saved some money before for downpayment but saved aggressively since I started the thread. I have the 15% and by the end of this year can probably get to 20%. However I do want to move my office from the current location as soon as possible and I am assuming it takes 18-24 months to get the whole process completed. The land is roughly 20% of the total cost and any bank would most likely want me to put the downpayment to acquire the land before they start funding it.

I did consider waiting for a recession but if I am going to occupy this property as a tenant and landlord for at least the next 20 years if not more, waiting for a downturn might just be equivalent to holding your funds to invest waiting for a market pullback which may not always work.

There is apprehension and starter inertia on putting together a project of this magnitude, but if it can be done reasonably levered with out blowing the budget, long term prospects are good both for the property itself and the business growth that will follow.

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Hi HI,

If you have the money, why not just buy the land now ?

What would the cost differential be for building now vs. downturn.

I spend a lot of time thinking about leverage in real estate, risk, cash opportunity cost.

"waiting for a downturn might just be equivalent to holding your funds to invest waiting for a market pullback which may not always work."

Well not really, I think you are on the verge of a usual mistake. I have made this mistake and the reverse (holding too much cash) with this type of thinking.

Holding cash waiting for a recession has risk. But it's not really in the same risk as leverage of 3M in a recession.

I had 2M real estate debt going into the GFC (2009), on income of about 700k/year and it was uncomfortable. Very uncomfortable. I think if I had 3-4M debt, I'm not sure if I would have made it. There was no concern about cashflow in the end, but you only need one or 2 things to fall down to cause distress. A recession is not really a black swan event so it should be in your plan. I guess if you have 10% of your porfolio in cash, that can be an inconvenience and frustrating if you are waiting 10 years instead of 5 for a recession but that won't hurt you much, whereas too much leverage can kill you. Now having 10-20% cash for years is not the same as having 80% cash for years either. So a it's nuanced.

Having 450k cash is uncomfortable. Murphys law is that as soon as you buy something, there will be a recession. However, purchasing the land or smaller premises maybe less risky.

I guess the amount of leverage you employ is a bit like cooking a cake. You want just the right amount of heat that won't result in burning your cake, but you also don't want the temperature (and leverage) so low that it doesn't rise.

I like to think of it in terms of risk mitigation and upside.

I am on the other side of your proposed development/build. I think it's always good to see who is taking the other side of your position and why.

I am accumulating cash in my retirement account. By the end of this year I'll have close to 1M. If a recession does not occur for another 4 years, then I'll have 1.8M to buy something. I intend to buy unlevered and am looking for a development block in the 1-2M range. I am not really into building anything, but if something comes up that is uncompleted due to lack of funds, I might buy it in my taxable account and sell it a few years later.

Sometimes I feel I should be using the funds to buy something that earns a better income than cash, but it's not that bad. My cash allocation is less than 10% of my portfolio value so it is not like a large proportion of my funds are in cash. And if there is no recession in the next 5 years, I will be over the moon because the other 90% of my portfoilio will be rocking along.

Coming out of the GFC I was 50% levered, then in 2014 I reduced to 30% and in 2017-18 I reduced leverage to 0% and raised 5% cash and have been letting that accrue. I am not really into taking on 75% leverage at this stage in the cycle in illiquid real estate.

One thing I have been careful with is real estate leverage and that kept me alive. Probably as a high earning professional, leverage is one of the few things that can kill you. Like someone said, if you know where you're going to die, don't go there !

It might work out well, some people I know operate through the cycle on a 70% LVR, but I wouldn't be able to do it. I don't really think you need to take those risks to do well.  Through the cycle I aim to have average 1-2M debt. Currently I have no debt, but at other periods I've had up to 3M.

Buying your practice building can be a good thing. It arbs the rent and you might also have a tax benefit. Calculating the returns people seem to make, most of them seem to be from building/land appreciation. You can do that without owning a practice building. In that sense I'm not really a CRE investor. I'm more a land speculator. I look out for opportunities to buy LT appreciating land. If I can also buy that from distressed developers and sell back to developers in a less distressed state that is a bonus.

Everyone has a different strategy and many can work out. Just make sure you know your risks and what you will do if you are wrong. What happens if your build does not go to plan, if there is a recession in the middle of it, etc. 10 years into a cycle I am thinking a recession is coming sooner than later. Like Robert Shiller said something like (I can't remember his exact quote): "it's like those obese people you know, even though it's unhealthy, they could keep going for a long time." Anyways, in terms of handicapping risks, I would bet the morbidly obese person dies earlier and so will the cycle come to an end. But I wouldn't bet on it necessarily happening in the next 5 years, so I have 90% in risk assets still. But I wouldn't bet they live for another 10 years either and take out 80% LVR here either.

I guess it's about balancing your risks vs taking opportunities. I just don't see too many good opportunities currently. But someone else might see something and they may do well out of it.

[HumbleInvestor]

Thank you for the feedback. I saved some money before for downpayment but saved aggressively since I started the thread. I have the 15% and by the end of this year can probably get to 20%. However I do want to move my office from the current location as soon as possible and I am assuming it takes 18-24 months to get the whole process completed. The land is roughly 20% of the total cost and any bank would most likely want me to put the downpayment to acquire the land before they start funding it.

I did consider waiting for a recession but if I am going to occupy this property as a tenant and landlord for at least the next 20 years if not more, waiting for a downturn might just be equivalent to holding your funds to invest waiting for a market pullback which may not always work.

There is apprehension and starter inertia on putting together a project of this magnitude, but if it can be done reasonably levered with out blowing the budget, long term prospects are good both for the property itself and the business growth that will follow.

[Dont_know_mind]

My 2c:

It could go on for another few years, but I don't want to be holding debt when the dancing stops.

I think most CRE at anything above 50% LVR is orders of magnitude more risky than unlevered land.

I would be more worried about loan terms than squeezing out 5% more leverage. At 85% LVR, the banks will get edgy about your loan before the 70% and so on.

If you are pulled on a 3-4M loan in a recession, you won't be able to raise more capital, get replacement leverage or sell your property.

I would rather wait for a recession and buy liquidated that is untennanted.

[gaspasser]

Yes. I’m asking around local banks. Have 6 loans total, 5 reset in 2019-2022. They all will payoff in 13 years (5/8/10/11/13 years).

Love to lock 3 into 15 year loans. PNC Suntrust local credit union...all working on it. Any national lenders?

[The White Coat Investor]

Most banks will refinance to 10-15 year fixed loans. Are you having trouble finding that option? Especially the 15 year. That must be the second most popular mortgage out there.

[gaspasser]

Where to find banks that will refi to fixed 10-15 year loans?

I have some RE loans 5/5 ARM over 25 yr @ ~4.5% due to reset in 2019-2022, would love to lock in longer term.

[mobilehomegurl]

You can also take on partners or use private money. Good luck!

[Medikit]

CREGuy wrote:

Medikit wrote:

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.

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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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Thanks, that's really helpful.

[Kamban]

The private lenders we have approached have now started to ask a 1.5-2% extra interest over banks.

Small to medium banks are more willing to loan nowadays to small owners of commercial business and real estate than large banks. But many of them run into a roadblock at around $5M and if the project is $7.5-10M, they need a second bank or additional SBA loan, which increases complexity.

Most banks don't do a 30 year commercial loan. Many start out with a 5 year fixed and balloon later. As stated, you want to do a refinancing by year 3.5-4 to a fixed 10-15 year rate. By paying down some principal and hopefully with appreciation of the property value, the next loan is on favorable terms.

[CREGuy]

HumbleInvestor wrote:

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.

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85 LTV is about as good as you'll find right now.  There are some private sources that would possibly allow you to get to 90 or possibly even higher, but most are going to come with a significant rate increase over what the bank is proposing.  As for the balloon, they're pretty typical in commercial financing.  I'd say only about 10% of the financing I see is fixed.  As I stated above, you would just need to be proactive in managing that debt and be sure to refinance well before you get to that 7 year deadline.  We're in a rising interest rate environment, so I would anticipate a higher rate when you do refi.

Given that you are going to occupy the space, you could always look at SBA financing.  That would allow you to get to 90 LTV with good rates, but it does add a lot of red tape to jump through and can encumber the property a bit (you're required to occupy at least 51% of the building).

[CREGuy]

Medikit wrote:

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.

Click to expand...

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.