Trey Stone explains the benefits of refinancing and how to refinance wisely in a down market like we are currently experiencing.
To access cash from the appreciation of a property
Over the years Trey Stone has done about 60-70 different loans for various apartment complexes. The total of that is in the range of $600,000,000 to $700,000,000 because he and his partners add value to a lot of these properties by upgrading them. These upgrades cause the value of the property to go up. Sometimes they want to continue owning that property but they want to access some of that cash from the appreciation of the value. To do that, they’ll refinance that property.
To change loan types
Sometimes Trey and his partners invest in a deal with a short-term bridge loan for a property that’s in distress. If the property isn’t making as much money as it should be based on comparable properties because it is run down or mis-managed, a bridge loan is often the first step until the investors can increase the value of the property. You typically have to put down a bigger down payment for a bridge loan and the loan usually has a higher interest rate. In this type of investment, Trey and his partners will refinance the property into a permanent loan once the value has increased to eliminate that high interest rate.
To maintain ownership of a property after the loan term runs down
Apartment loans are usually around 5 years. Trey has had one of his properties for about 14 years so he’s been through multiple loans. When he first bought it, he had a Fannie Mae loan with a 10 year loan term. Now he has a CMBS loan or a Commercial Mortgage Backed Security loan for a little over 20 million dollars. The value of the property today is closer to 50 million dollars.
As a result, when this loan term runs down, Trey will refinance it again because he has no intention of selling the property. Trey will take some of the money from the new loan to invest in new properties and still have a lot of equity left in the property. The value of these properties goes up from the improvements but also as you own them over time because of compound interest. Maintaining ownership of properties long-term can sometimes be extremely beneficial.
If you’re in a real estate investment deal where you’ve done a Fannie Mae, Freddie Mac, HUD loan, or CMBS loan and you’re looking for your next refinance you should work with a local mortgage professional.
Trey recommends this approach because they will take your loan application and they will send it out to get you quotes from several lenders who are looking for those types of properties. There are several different commercial product types and different lenders might be looking for different investment types. If you work with a mortgage broker from a big firm, they’ll come back with a matrix and a spreadsheet that shows the bids, the top three lenders, and the summary of why they’re the best.
By working with a local mortgage professional, you are working closely with people in your own community who know other community members and a close eye on what types of investments they might be looking for. These relationships often link the right people together for the best partnerships possible rather than a matric and a spreadsheet.
Trey also warns that if you refinance in a market like this one, do not let your lender determine the property value based on an “as-is” appraisal. An “as-is” appraisal means the lender is saying how much the property is worth right now based on a trail of historical financial statements. The higher the value comes in, the easier it will be to pass any hurdles to get your loan closed.
A great way to get a high value in a down market is to get an appraisal based on an “as-stabilized” value. The difference is an “as-stabilized” appraisal is using your proforma of what the net-operating income for the property will be in the future. That gives you a little bit of room to maneuver.
For example, let’s say we look at a property where you will make some upgrades: new appliances, new flooring, new countertops, new kitchen cabinets, enhance the lighting, and replace hardware.
You plan to spend a million dollars on the upgrades
Your value will increase from those upgrades
An apartment was renting for $800/month before the upgrades and now it will rent for $950/month.
You will increase the value by $150/month for each apartment.
Multiply the added value by the number of apartments to get the monthly added value amount for the property
$150 x 264 units = $39,600
Multiply that monthly added value amount for the property by 12 to get the annual value increase
$39,600 x 12= $475,200
This added value was calculated as if the property was completely full and all apartments are rented. Realistically, occupancy will likely be closer to 90%
Multiply the annual value increase amount by 90% for a realistic calculation on value increase for that property
$475,200 x .9 = $427,680 in added value to the property
In this example when you request to refinance, the lender would determine that the value of the property will increase by over 8.5 million dollars based on the “as-stabilized” appraisal. They will use the $427,680 per year value increase and a CAP rate formula to determine this “as-stabilized” value. The bank will make you escrow a million dollars to know that you have the money to make the improvements but by borrowing an extra million dollars you are able to increase the value by 8.5 million dollars. This is a great investment and a way to refinance in a down market.
Pay Attention to Interest Rates and Prepay Penalties
It’s always better to access equity on a property when the interest rates are low.
Interest rates are really low right now during the down market that we’re experiencing from the COVID-19 pandemic. Prepay penalties can occur when you pay off a loan early so it’s important to understand your loan terms before refinancing. Sometimes your savings on a refinance ends up being so much more than the interest expense on a new loan that paying the prepay penalty to your old lender is worth it. It also may be better to take a loan with a higher interest rate if it doesn’t have prepay penalties.
Because of the opportunities available with low interest rates and deep discounts on properties in this down market, the time is now to invest. Choosing the right partners and mortgage professionals is key to your success as an investor. There is opportunity to generate wealth in a down market when you have the right team in place to make the best decisions for the investments.
“Each of us only have so many business cycles of buying low and selling high before the end of our career.” -Trey Stone