Over the past six months, we’ve done a lot of commercial deal analyses that generated significant interest from our audience. Commercial lending tends to be more creative than residential lending, and borrowers have many different levers they can pull. While the commercial lending environment is changing due to rising interest rates, deals are still getting done.
Today, we’re looking at an investor who transitioned from multifamily properties to triple net lease properties and wanted to prepare for retirement. Strategic Partners William Foy and Marcus Davis of Spearhead Commercial join me to talk about how they helped him navigate the new environment and share the unique difficulties borrowers are facing these days.
- Listen to the podcast “#417: When Is an ARM Better than a Fixed Rate Loan?” 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.
Transitioning from Multifamily to Triple Net Properties
The investor is part of a couple who inherited some multifamily properties about 30 years ago. He’s been operating the properties in Littleton and Englewood and like many folks, saw a wave of appreciation. He sold off some of the properties in order to obtain triple net properties that are more passive. These investments performed well, and his portfolio is valued at $25MM.
Marcus was introduced to him 18 months ago when he wanted some help optimizing 3 of his 6 triple net properties. The properties are spread across three different states: a Caliber Collision company in Florida; an oil and gas service company in Texas; and a learning center in Colorado.
The client’s main goals were to refinance to pull out cash and avoid prepayment penalties. He is getting close to retirement so he plans on selling off his properties in the next few years.
The existing loans had prepayment penalties, and he wanted to take advantage of the low interest rates at the time. After Christmas of last year, he had the opportunity to pull the trigger and secure a rate that would result in savings and allow him to pay off the loans.
What is a Swap Prepayment Penalty?
Typically, prepayment penalties are based off of a percentage of the loan. A swap prepayment penalty is a mechanism that’s measured off of treasuries and your loan amount. When interest rates go up, the fees go down and vice versa. The reason for this is because a lender can generally reloan the money at a higher rate when interest rates go up, similar to bonds.
Unfortunately, no one predicted the war in Ukraine, which sent the interest rate environment into shock mode. This caused the borrower’s options to change and forced Marcus to get creative.
Navigating a New Environment to Find the Right Terms
The borrower had the option to do a 3-year fixed rate loan, but the interest rate would be 5.5%. Instead, they looked at adjustable-rate mortgages (ARMs), which typically have lower rates. Another benefit of ARMs is that they don’t tend to have prepayment penalties. The risk with ARMs comes from the fact that the interest rates on them change.
In this case, the ARM loan could change on a monthly basis. However, because the 3.5% starting rate was so much lower than what the client was currently paying, he would be able to pay off the loan before it hit his current rate.
The loan is a 3-year term, with a balloon payment after 3 years. This timeframe worked for the borrower because he already intended on paying off the property before that point.
After looking at many spreadsheets and explaining to the borrower how he would be able to accomplish both of his goals with this loan, he agreed to move forward.
How Is Spearhead Navigating Challenges in the Current Market?
Marcus and William say it’s more difficult to get loans in the current market. They spend a lot of time getting updates from lenders, and the lenders’ competitiveness changes on a monthly basis.
It’s becoming more uncommon for lenders to do a rate lock. They tend to be pricier now and only guaranteed for 60 days, as opposed to the usual 90 days.
While they always take their clients’ priorities into account, William and Marcus want to be realistic, too. They manage client expectations within the current market and make sure that lenders will be able to deliver over a 45-90 day time period. This can be difficult to navigate when interest rates continue to climb and lenders are worried about being underwater on a property within 12 months.
What Should Investors Know about Transitioning from Multifamily to Triple Net Properties?
Triple net is a lot of fun to explore and provides reliable cash flow because of the lease design. Investors should start by looking at publicly traded companies and reviewing their financials to see their ability to perform on leases. It’s common to see 20 year leases, giving investors predictability without the work of maintaining the property.
There are a lot of brokerage groups who specialize in this lease type, so investors should rely on them.
William and Marcus haven’t seen inflation having an effect on returns for this property. The biggest impact from inflation is that it drives interest rates up.
Connect with Spearhead
If you want to see how William and Marcus can help you with a commercial loan, reach out to them. A brief conversation will help you both determine if they can assist you with your lending needs.