Negative leverage

[DanBuck]

Hi all,

Just wanted to hear peer opinions about Rm>Ro or the mortgage constant being greater than the cap rate. Generally this is seen as negative leverage(although yield rate more implicit). However in markets where property values may be expected to rise, this negative leverage may not be such an issue. With which types of lenders and banks would you be careful not to show Rm>Ro at all, and which type situations can it differ and be acceptable to lenders.... Any experience or insight on this is welcome.

TIA

 

[WestMichiganCG]

Brokers are spinning the tale of "marry the property and date the interest rate" so investors think they can refinance at a lower rate later. The other factor at play is all cash buyers looking for somewhere to dump money as a 10-year lease may be worth a 5-cap if your 100% equity. It's getting dumb, I would rather buy a CD than have the equity dividend rates of some of the investments I'm seeing.

 

[DanBuck]

Brokers are spinning the tale of "marry the property and date the interest rate" so investors think they can refinance at a lower rate later. The other factor at play is all cash buyers looking for somewhere to dump money as a 10-year lease may be worth a 5-cap if your 100% equity. It's getting dumb, I would rather buy a CD than have the equity dividend rates of some of the investments I'm seeing.

Interesting . Many investors can justify marrying property and date interest rates. History has been on their side. But Im asking from the perspective of a lender or for an appraiser whos submitting a report to a lender that shows borderline or negative leverage, how do you go about explaining that..

 

[WestMichiganCG]

Interesting . Many investors can justify marrying property and date interest rates. History has been on their side. But Im asking from the perspective of a lender or for an appraiser whos submitting a report to a lender that shows borderline or negative leverage, how do you go about explaining that..

Attach a list of derived capitalization rates of similar properties and say that you're basing your capitalization rate on the actions of market participants. If everyone is paying a 5.5% cap on restaurants you're not going to argue for 7% because you did the band of investment and used a 70%/30% split.

 

[DanBuck]

Attach a list of derived capitalization rates of similar properties and say that you're basing your capitalization rate on the actions of market participants. If everyone is paying a 5.5% cap on restaurants you're not going to argue for 7% because you did the band of investment and used a 70%/30% split.

Yes that can be done. But many underwriters cant accept a significant Rm>Ro. Or just need it to look clean. This is a system malfunction..

 

[WestMichiganCG]

Yes that can be done. But many underwriters cant accept a significant Rm>Ro. Or just need it to look clean. This is a system malfunction..

I've left the band of investment out of the report when it doesn't make any sense. Sometimes when we run into weirdness we'll interview the market participants and ask them what their thoughts were on the transaction. You could also talk to brokers.

 

[DanBuck]

I've left the band of investment out of the report when it doesn't make any sense. Sometimes when we run into weirdness we'll interview the market participants and ask them what their thoughts were on the transaction. You could also talk to brokers.

Leave out BOI a good idea..Again, we're speaking in a case where market participants and brokers agree to invest in such a deal that is borderline negative leverage-yet it still may not meet lender underwriting guidelines, even with proof from market participants..

 

[WestMichiganCG]

Leave out BOI a good idea..Again, we're speaking in a case where market participants and brokers agree to invest in such a deal that is borderline negative leverage-yet it still may not meet lender underwriting guidelines, even with proof from market participants..

Cap. rates are going up in my area, just less so for prime real estate.

 

[David S]

Hi all,

Just wanted to hear peer opinions about Rm>Ro or the mortgage constant being greater than the cap rate. Generally this is seen as negative leverage(although yield rate more implicit). However in markets where property values may be expected to rise, this negative leverage may not be such an issue. With which types of lenders and banks would you be careful not to show Rm>Ro at all, and which type situations can it differ and be acceptable to lenders.... Any experience or insight on this is welcome.

TIA

Quite often in my area the mortgage constant being greater than the cap rate. I saw a formula from a appraisal book p=c-d, p is for the property price appreciation rate, d is for discount rate, c is for cap rate. It means if discount rate (not sure the same as mortgage constant) is lower than cap rate, that area house price must be up. Otherwise, no investor will buy the property there.