Usually, our deal analyses focus on an investor who is midstream or just beginning their investing cycle. Today, though, we’re looking at a deal for an investor who’s at the end of his cycle. Strategic Partners Marcus Davis and William Foy of Spearhead Commercial Capital joined me to talk about how they refinanced an investor’s office space, and why it’s a win for him and his goals.
- Listen to the podcast “#383: Getting $250k Cash to Replace Lightbulbs? A Creative Method for Pulling out Equity in an Office Building Refinance” Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
Who Is the Investor?
The investor is an older gentleman on the backend of his investing career. He’s had a very successful, 50 year run of real estate investing, starting with single family rentals in Wyoming, maturing to multifamily complexes, and eventually office space as well. Now that he’s winding down, he’s selling off assets year by year and is down to his last few assets.
His overall strategy is a bit of a rarity in today’s world. He’s always focused on low leverage, having invested during the 1980s when interest rates were double digits. With this asset, he’s at 45% leverage with cash out, which is high for him.
He’s won a lot on exiting deals and doing 1031 exchanges. Generally, he doesn’t like to go back to the well and refinance to benefit from a better rate or pull out cash.
Finding a Strategy that Matches the Investor’s Goals
Marcus drives by the property almost every day, and after completing a deal for the property across the street, decided to reach out to the investor via cold call. The investor told him he’d be interested in working with Spearhead if he could get a lower interest rate.
Originally, the loan was 4.5% and was in year 3 of a 5-year note. There were two years left on the remaining term, which had a 1% prepayment penalty.
At the time they reached out, the pandemic was just starting and everyone was spooked. Lenders were saying no to office spaces as existing tenants were exiting buildings and hesitant to sign long term leases.
The owner of the office space was facing some challenges: his rent roll was at only 60%, and tenants were not just exiting the property but breaking their leases, too. Marcus focused on getting the investor in a place where lenders would feel comfortable from a rent roll and occupancy standpoint.
The basic rule of thumb for lenders in commercial real estate is debt service coverage of 1.2, 1.25 or greater. Above 70% occupancy usually fits most policies, but 75% occupancy is preferred. Lenders try to match the term of the loan with the term of tenant leases. They don’t want to commit to a seven-year deal if the property owner is going to have 100% turnover in that time.
Getting the Deal Across the Finish Line
Marcus was in conversation with the property’s bookkeeper monthly. He was keeping track of new rent rolls and doing his own underwriting to make sure the rent roll could satisfy occupancy requirements. He tracked the property for 18 months before they were ready to go.
In January of this year, the occupancy was at 72%, giving them the ability to move forward with formal approval. They’d been working with a lender for eight months, and he was eager for the deal to move ahead.
Once they got formal approval, they were able to close the deal in 60 days. The capital markets were rocked by the outbreak of war and rates went sky high. While they were still able to close, the interest rate unfortunately jumped from 3.75% fixed for 5 years to 4.35%. Overall, though, the client was happy because this was still lower than his original interest rate.
All in all, he was able to get a lower interest rate and obtain more flexibility to sell the property if a good opportunity comes along. Marcus was able to add a waiver that allows him to sell with no penalty. The only penalty that would apply is if he were to refinance again, which he has no desire to do. This made the client feel comfortable and fits his overall strategy.
Finding a Creative Method for Pulling Out Equity
The client wanted a cash out refinance, but many lenders want to know the reason for the cash out. Do they want to pay off the property, buy another property (and thus potentially do more business), or do they want to spend it on something like a sailboat?
In this case, the client just finished replacing the lighting with LEDs, which cost him $250K. He was able to assign value to that project because it sat on his balance sheet like an asset. The bank said it would give him the dollar amount he requested, but told him it needed to go to next year’s taxes. Banks feel more comfortable when they know that the money is going towards taxes or to a fixed cost for the building because it minimizes risk.
Luckily, the client already prepaid those taxes, so he was able to free up some cash.
Connect with Marcus and William
If you want to connect with Marcus and William about your own portfolio, reach out to them at https://spearheadmortgage.com/. Fill out the questionnaire on their website and one of them will reach out to you directly. They’ll bring you the best quotes and help you figure out a strategy.