Printer Friendly

Sometimes, prepayment penalties make complete sense.

Now is a terrific time to refinance. While properties that have freely prepay-able mortgages have been actively refinancing their mortgages, more and more owners of multifamily and healthcare properties are paying sometimes large prepayment penalties--often in the form of defeasance or Yield Maintenance payments --for the sake of locking in today's low rates for the longest term possible.

For example, several property owners have been taking advantage of the FHA programs that provide 35year, self-amortizing financing with rates in the low 3%-range. Let's take a closer look at how one might evaluate whether it makes sense to incur a large prepayment penalty for the sake of securing this type of financing.

To start, we look at the net present value of the debt service savings by refinancing now for 35 years compared to refinancing later at a "normalized" interest rate (say 5.5% to 6.5%). The resulting differential is often several million dollars.

When you add to that the savings in transactions costs from potentially only needing one loan for the next 35 years instead of one every five to 10 years, as well as the cash-out proceeds that might be generated from today's high property values, it's easy to see how the benefits can easily outweigh the costs of prepayment.

Furthermore, by acting now, borrowers are getting the immediate benefit of increased cash flow from lower rates and the ability to reinvest any cash-out proceeds in property enhancements or other investments.

Many property owners also believe that with this low interest rate and long-term financing being assumable, it may result in an increased cap rate at the time of disposition.

While FHA loans can take some time to process and close--often close to six months from application virtually all properly owners are happy they endured the process at the end, and it is not unheard of to find an owner dancing on the closing table when they finally get to the finish line.

Some conservative owners who have historically eschewed higher leverage on their portfolios might bristle at the thought of 80% financing (83.33% if no cash-out).

However, this concern is mitigated by the 35-year self-amortizing term that eliminates the risk that one might potentially find him/ herself forced to refinance in the future in a high interest rate market.

Additionally, the FHA underwriting imposes some additional conservatism in their underwriting as they require a minimum of 1.20x debt service coverage, assuming a minimum residential vacancy rate of 7% and a minimum commercial vacancy rate of 10%.

Furthermore, at today's low rates, amortization makes up more than 30% of the monthly debt service, thereby building equity more rapidly.

The old adage is that "it takes money to make money" (though many real estate operators have given this refrain a run for the money!).

What is recited less frequently is that, sometimes, it also takes money to gain security and peace of mind.

With interest rate levels at their current low levels, all property owners should be examining not only their loans that are maturing in the next 12 months, but also those that are maturing in the next 12-36 months to evaluate if the interest rate savings, cash-out proceeds (if available) and--last but certainly not least--the concomitant peace of mind that comes with long term financing might justify paying the larger prepayment penalties.

By Mordecai Rosenberg and David M. Hall THE GREYSTONE BASSUK GROUP
COPYRIGHT 2013 Hagedorn Publication
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2013 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Author:Rosenberg, Mordecai; Hall, David M.
Publication:Real Estate Weekly
Geographic Code:1USA
Date:Apr 3, 2013
Words:569
Previous Article:HFF arranges $39m acquisition financing for Jersey hotel.
Next Article:Fraud and the limited liability company.
Topics:

Terms of use | Copyright © 2018 Farlex, Inc. | Feedback | For webmasters