What To Do When Loans Reset At Higher Rates?

The long awaited pull back in pricing for apartments is here. These properties don’t need to necessarily be poorly performing. It’s the properties that were financed with bank debt from small local and regional banks. These smaller banks typically offered loans with a 20 year amortization period and if the loan was written five years ago, the 10 year Treasury yields were pretty low at 0.7%. The loan written five years ago would have been priced in the mid 4’s. Oh, and here’s the important part. It would have been written with a five year term. That means the loan would need to be renewed at current rates in five years and that five year period is up now. 

The borrower has the option to renew with the lender at the current rate with a new loan. But at today’s higher rates, even if the property is performing well, the borrower is likely to be forced to bring additional cash to the table. 

The situation can be improved by moving out of the local bank financing into agency debt with a longer amortization period. Instead of a 20 year loan, maybe a 25 or 30 year loan will reduce the loan payment enough to make the numbers a little more palatable. 

--------------

**Real Estate Espresso Podcast:**
 Spotify: [The Real Estate Espresso Podcast](https://open.spotify.com/show/3GvtwRmTq4r3es8cbw8jW0?si=c75ea506a6694ef1)  
 iTunes: [The Real Estate Espresso Podcast](https://podcasts.apple.com/ca/podcast/the-real-estate-espresso-podcast/id1340482613)  
 Website: [www.victorjm.com](http://www.victorjm.com)  
 LinkedIn: [Victor Menasce](http://www.linkedin.com/in/vmenasce)  
 YouTube: [The Real Estate Espresso Podcast](http://www.youtube.com/@victorjmenasce6734)  
 Facebook: [www.facebook.com/realestateespresso](http://www.facebook.com/realestateespresso)  
 Email: [[e-mail]](mailto:[e-mail])  
**Y Street Capital:**
 Website: [www.ystreetcapital.com](http://www.ystreetcapital.com)  
 Facebook: [www.facebook.com/YStreetCapital](https://www.facebook.com/YStreetCapital)  
 Instagram: [@ystreetcapital](http://www.instagram.com/ystreetcapital)  

Episode Transcript

(00:01):
Welcome to the Real Estate Express podcast, your morning
shot of what's new in the world of real estate investing.
I'm your host, Victor Minash. The long-awaited pull back in
pricing for apartments is here. These properties don't need
necessarily to be poorly performing.
It's the properties that were financed with bank debt from
small local regional banks that are a problem.
These smaller banks typically offered loans with a 20 year

(00:23):
amortization period and if the loan was written five years ago,
the 10 year treasury yields werepretty low at 0.7%.
That loan written five years agowould have been priced in the
mid fours. Oh, and here's the important
part, most would have been written with a five year term.
That means that loan would need to be renewed at current rates
five years from the date of signature.

(00:43):
And that five year period is up now in a lot of cases, the
borrower has the option to renewwith the current lender at the
current rate with a new loan. But at today's higher rates,
even if the property is performing well, the borrower is
likely to be forced to bring additional cash to the table.
The lender is going to reprice the loan somewhere between 6:00
and 7%. In today's market.

(01:03):
Still with a 20 year amortization, that means a much
higher loan payment and the property will switch from
positive cash flow to negative cash flow.
And naturally, the lender is notgoing to allow a property to
operate with negative cash flow,so the loan amount will need to
be reduced to bring the loan back into balance.
That often means a hefty cash injection from the borrower.
Not many investors are thinking they want to invest more equity

(01:26):
into their existing assets for no other reason other than to
just satisfy a lender. Some simply don't have the cash.
Some don't know how to raise thecapital.
Some are at an age where they'rerelying on the property to fund
their retirement. They simply don't have the time
to wait another five years for the property to come back into
balance. These properties are now
starting to appear in the market, selling for a discount

(01:48):
to what was paid for them only afew years ago.
These sellers are backed into a corner and they're looking to
get out. The situation can be improved by
moving out of the local bank financing into agency debt with
a longer amortization period. Instead of a 20 year loan, maybe
a 25 or 30 year loan will reducethe loan payment enough even

(02:09):
with the higher interest rates, in order to make the numbers a
bit more palatable. Much of the commercial real
estate press has focused on the perils of bridge loans
converting into permanent financing, but we're seeing
problems in the market for stabilized properties that have
already converted to amortized loans.
Some of these shorter amortization loans do have a
path to maintaining their cash flow by converting to a longer

(02:30):
amortization, but the key is going to be to determine the
term of the loan with the longeramortization agency.
Lenders like Fannie Mae and Freddie Mac do offer longer
amortization, but they have 5-7 and 10 year terms.
The borrower could face the samedilemma at the end of that term
depending on what's happening inthe world of interest rates at
that time. The best financing out there is

(02:51):
the HUD 223F loan, which in today's market would be pricing
below 6% with a 35 year amortization.
That's one of the longest options out there.
These loans do require a lot of paperwork and they're not that
easy to get. The HUD loans are fully
amortized loans where the loan term equals the amortization.
So you're not going to be resetting the loan anytime in

(03:12):
the next 35 years. It's truly permanent financing,
and if you can make the numbers work at the start of the loan,
you should have financial stability for the duration of
the loan unless you grossly mismanage the property.
Some of these properties are appearing in the market, selling
at a discount in many cases because the borrower simply
lacks the lending relationships that enable them to get access
to better financing. Many borrowers have

(03:33):
relationships with their local bank.
Maybe they've been dealing with them for decades.
The notion of changing to a larger national institution
seems daunting. The lender might require
additional balance sheet strength that the borrower
simply doesn't have, and as such, the better financing seems
out of reach. I'm actually in conversation
right now with the owners of twodifferent portfolios who are
precisely in this situation. They're more inclined to sell

(03:56):
the properties at a loss than toconsider getting better
financing. They are aware that better
financing exists in the marketplace, but they don't know
where to start when it comes to getting access to a more cost
effective loan. The obstacle is that some
lenders require larger aggregatenet worth.
In recent years has made access to the best financing more
difficult to attain. These loans from Fannie Mae and

(04:17):
from HUD are non recourse loans.They're also assumable, which
means you can sell the loan withthe property, assuming, of
course, the buyer qualifies for the loan.
And then we don't know what willhappen in terms of policy
changes. There are initiatives underway
that would privatize the nation's largest agencies that
are currently under conservatorship by the US
government since the 2008 financial crisis.

(04:38):
This change, if and when it happens, may bring about
additional policy changes. And we may also see policy
changes within HUD. We've seen them already within
the Small Business Administration loans.
Combination of higher interest rates and lending policies are
clearly having an impact on the health of the multifamily
apartment market. This is a time where you want to
be working with commercial mortgage brokers who are truly

(04:58):
experts in the best financing inthe business.
As you think about that, have anawesome rest of your day.
Go make some great things happenand we'll talk to you again
tomorrow.