INVESTORS: Now is the time to negotiate provisions in your commercial real estate mortgage to allow you to leverage current low interest rates to your advantage when interest rates rise. Here’s how:
In one respect, the value of locking in low interest rates for extended periods when interest rates are likely to rise is obvious. If you knew today that interest rates were rising and that in the foreseeable future interest rates were going to be 7.5%, 8.5%, 9.5% or higher, who wouldn’t lock in today’s low interest rates if they could? That is not really the issue. That concept is self-evident.
But what if, for example, you lock in a low interest rate today for the next 10, 20 or 30 years – interest rates rise significantly, and then, say 5 or 6 years from now, https://fastcashloan.net/payday-loans-ga/ you wish to sell your investment?
The original Investor would “cash-out” at the time of funding this loan and the original first Mortgage loan would be paid off
Assuming pre-payment of your loan is allowed , one solution is to simply sell the property. In this case, you would receive your equity and would be free to reinvest at then prevailing returns. Unless you have a “portable mortgage” allowing transfer to a new project, you would promptly loose any future benefit of your long-term low interest rate because the project would be gone and, most likely, the mortgage paid off.
If the mortgage is “assumable”, you may gain some advantage by being able to negotiate a higher sale price for the project because the assuming buyer will be able to benefit from your lower rate. An obvious problem with this scenario is that, if the project has appreciated substantially, the amount of the down-payment the buyer may be required to produce to pay the equity between the purchase price and the remaining loan balance may be prohibitive to most buyers, thereby reducing demand for your property and creating downward pressure to lower the price.Are there other solutions?
Today: Investor acquires an office building, strip shopping center, single use building, or other typical investment property (the “Property”) for $2,000,000. 25 % amortized and payable over 20 years, secured by a first Mortgage on the property.
Five years later: Now, project yourself five years into the future: Interest rates on first mortgage loans have risen to 9.5%. 5% to 11%. Because of built-in rental increases under existing leases, the Property has appreciated in value to, say, $2,200,000. Perhaps the tax shelter benefits of the Property to the Investor have diminished somewhat because the Investor used segregated cost accounting to accelerate cost recovery in the early years of the investment, so Investor has decided to sell. The sale price is $2,200,000.
Case No.1. Investor could simply sell the property to a willing buyer (the “Buyer”) who would be responsible for obtaining its own financing. Under a typical scenario, the Buyer will obtain a mortgage loan for 75% of the value of the property at current market interest rates. Under the hypothetical facts given, the Buyer will invest equity of $550,000 (25% of the purchase price) and will obtain a first mortgage loan in the amount of $1,650,000 (75% of value) at a current interest rate of 9.5% amortized over 20 years, with a 15 year balloon payment . The Buyer’s monthly payment would be $15,. The balloon payment due in 15 years would be $732,.
Interest rates on loans secured by second position mortgages are, perhaps, 10
Case No. 2. If the Mortgage is “assumable” (or, at least, not “due-on-sale ), the Buyer could, if it chose to do so and the Seller agrees, pay the original Investor an amount equal to the Investor’s equity in the Property and “assume” or “take subject to” the Mortgage obligation with its low 6.25% interest rate for the balance of 15 years. If this were to occur exactly 5 years after the original investment, the Mortgage balance would be $1,278,, requiring the Buyer to invest $921, as its equity to acquire the Property and receive the benefit of the lower interest rate. An investor may be willing to do this, if it has the funds available and is willing to make a 42% cash outlay for an investment property to achieve a below market interest rate. Investor preferences, however, typically favor a lower down payment.