Quote I love: “In reality, the best answer is likely the diversity of lending sources and loan types in order to maintain some flexibility of capital for future growth and also lock some backbone properties in long-term to lessen the risk on the overall portfolio.” - Richard Alexander of Grandbridge Capital
More to come with Richard below.
Mental Model: Two in one and one is none.
We have a major storm last week that swept across our entire portfolio. Thankfully we did not have much damage, but it did reveal just how fragile we are. We are now drafting emergency preparedness procedures, lines of communication, and best practices for an impending storm.
I recently spoke with Richard Alexander who is a Commercial Mortgage Banker with Grandbridge Capital. Richard works with the big-time operators (not sure why he took my call!), securing high-dollar loans on all property types with CMBS Lenders, Life Insurance Companies, Banks, Debt Funds, Agencies, and FHA/HUD. I am grateful for the time he spent with me to chat about strategy.
“It’s all risk & reward. Locking in the long-term debt lessens default risk during the term, refinance risk along the way, and interest rate risk along the way.” Explained a little further below:
Default Risk
1. On a permanent loan, you’re either paid current or you’re not. There is no default beyond that from an operational perspective.
2. On a bank loan, there is also covenant default to think about, DSC, LTV, Liquidity Covenants, etc.
3. Additionally, lower leverage at a lower rate obviously comes with a lower payment and lower chance of default. Further, all you have to do is make the payment to avoid default. On the bank loan, you need to maintain the ~1.25x DSC coverage, and whatever else was agreed to.
Refinance Risk
1. Hypothetically, you lock in a 10-year or longer fixed rate term. Any movement in cap rates or interest rate in between the closing and maturity are inconsequential. And by time you’re at the end of that term, you’re likely dealing with a very lowly leveraged assets from principal amortization and, hopefully, cash flow and asset appreciation.
Alternatively, you can go with a 5-year rate. You have to refinance in 5 years and are at the mercy of the cap rate and interest rate environment at the time. And, depending on the amortization, you likely haven’t amortized much principal at that point. You’ve also had less time to increase cash flow and value, so you’re more likely to run into a problem. Potentially, it could be difficult to refinance the debt and you could be the hook personally on top of that.
Interest Rate Risk
1. This also falls into refinance risk, but when you renew a loan in the interim of what would have been middle of a 10+ year term, you’re at the mercy of the market and the prevailing interest rate.
Honestly, in our careers, (having started in real estate lending in 2009) we’ve not seen these risks rear their ugly heads very often or for very long. Truth is, in our time, the best thing you could have done with a portfolio is to maintain floating rate debt. Looking back, that was a clear winner. Now, I’m certainly not advocating moving everything to floating rates for marginal interest rate improvement. But, the problem with maintaining the bank flexibility of capital is the potential for these risks to pop up overnight. So, it once again comes back to risk.
“In reality, the best answer is likely diversity of lending sources and loan types in order to maintain some flexibility of capital for future growth and also lock some backbone properties in long-term to lessen the risk on the overall portfolio.”
Thank you for making us all a little smarter Richard. For more about Grandbridge Capital and Richard, check him out Here.
Lagniappe:
It was short and sweet today. If you enjoyed this today, please forward it to another curious friend. I love your replies to The Real Deal. I read every single one, and I try to respond as often as I can.
www.pearsonpartnerspe.com