Is it Really All About Rate?
11th August 2017
Is It Really All About Rate? You might conclude that it is. You may think that securing the lowest rate is key to your real estate investment success. However, rate is but one of the four main components of any commercial mortgage offer. Amount, term and amortization period are also critical factors. It’s all related to your overall investment strategy, and your property specific goals.
Loan Amount is often the critical component of your financing. This is particular true in the case of a property purchase. The loan amount will drive your other considerations. You may have secured a great low rate, but if you lender is only prepared to provide you a loan equal to 60% of purchase price or appraised value, are you prepared to inject additional equity? Have you considered what this will do to your real estate return? Will you need to source secondary financing, and if so, at what cost? Will you need to seek partners or co-investors to complete your property purchase?
Important, but often overlooked, is the term of your financing. In our post entitled Mortgage Term Preferences, we outlined borrower preferences for length of mortgage terms selected. The importance of developing a real estate strategy cannot be overstated.
Are you a buy and flip investor, or are you interested in a long term hold? How long are your primary Lease terms? Perhaps you acquired the property at an advantageous price. You may have created value by releasing to stronger tenants at higher rents. Perhaps you’ve updated the property. Are you now locked into an inappropriate mortgage term, unable to “release equity” to leverage this added value?
What is your portfolio strategy? If you have several assets, conventional wisdom would suggest that you stagger your mortgage maturities.
What is your property specific exit strategy? If you’ve maximized value, and little future value upside is available in the short term, do you want to position yourself so that you can entertain an Offer to Purchase without having to consider potentially costly mortgage prepayment penalties?
Conversely you may have acquired the property with the expectation that it will represent a major part of your future retirement strategy. Is a longer mortgage term more appropriate, with certainty of mortgage payments? All of these considerations will inform your decision regarding length of Term.
From personal experience, often little attention is paid by Borrowers to amortization periods. Your preference will be guided by your investment strategy. Your need to manage cash flow, and the specific income generating characteristics of your property will be key.
Is it important to you to be debt debt free by a particular point in time? Do you want to grow your property specific or portfolio equity so that you can leverage the asset(s) for future acquisitions? Conversely, are you in a joint venture ownership situation, where investors are looking for the maximum cash flow? All of these considerations will inform your amortization period decision.
Rate is the component which garners the most interest (pun unintended). But is it less critical to your financing plans than you’ve previously thought? A keen rate offered by a lender who can only provide you a 5 year term, on a 20 year amortization, with no prepayment privileges, may not be the right loan for you.
If you are conventionally financing a well leased commercial asset in a major centre, chances are that a number of lenders will be interested in your investment opportunity. Lenders will be competing for business like yours. They will have a budget for annual loan approvals. As such, available market rates from major “A” lenders will likely not differ greatly. Rates are at a historically low point. Though rate upside is a concern, few are expecting rapid, nor exorbitant increases.
Your Investment Strategy will be Key
So Is It Really All About Rate? No, it is not. By all means consider rate, but ensure that all the loan terms align with your property specific, and overall portfolio strategy. Choose your lender wisely!
Understand which of these 4 factors or combination of factors is most important to you. All are negotiable to a greater or lesser extent.
Perhaps you need a full loan for an acquisition, so loan amount will be the critical piece. Paying a slightly higher rate, in exchange for the “right” loan amount, so that you can make effective use of debt, may be a wise decision.
Possibly debt service coverage and sufficiency of cash flow is key to your strategy. You may anticipate a softening of rental rates, or possible anticipate a vacancy increase. Focus on securing a comfortable (i.e. lengthy) amortization period.
Perhaps a number of your Leases are structured to mature in 36 months. Arrange the term of your loan to coincide. Taking a a 5 year term may lock you into waiting an additional 24 months before you can secure an increased loan (without going the secondary financing route).
Understand what is important to you. Implement your commercial real estate investment strategy accordingly.