How do I model a loan refinance for a real estate modeling exam
I am doing a modeling practice exam where you have to model a real estate development, and it says that there is an initial construction loan which is LTC, but there is also a section that says "refinance", which has LTV at a given cap rate at FTM NOI (I'm assuming 12 months forward?), and it has a lower rate. How would I model this exactly?
I am also a bit confused because there is a waterfall structure as well. So for the waterfall, am I using the levered cash flows?
Thanks for any help
If you want to pm a link to the model I'd be happy to give you my 2 cents.
I'm still relatively new in the industry but I've worked on a few multi-family development deals thus far and can tell you what I've seen. Happy to hear how others have experienced this.
In the deals that I have worked on, the construction debt usually comes from a debt fund and as such has a very short term on it and a high interest rate, given that the collateral for the note is yet to be constructed and there is often minimal to no cash flow generated during construction. The amount loaned here is based on a percentage of the total construction cost.
Once the projects are stabilized (we've seen this defined based on percent completed and/or occupancy), we can go to other lenders who are only willing to lend against a stable cash-flowing asset. Life insurance companies tend to be lenders in this space. This type of debt comes with a longer term and a lower interest rate given that life insurance companies have a lower appetite for risk and are interested in long term stable cash flows.
The amount that these second lenders are willing to loan against the asset is based on the NOI of the property at some market cap rate. On a good deal, this value is much higher than the cost of construction. The LTV amount is used to pay off the construction note and the excess proceeds can be distributed to the development partners.
These excess proceeds get put through a waterfall to determine each partner's share. There are sometimes specific waterfall structures for refinancing proceeds. The annual levered cash flows can also be distributed through a waterfall depending on what the partnership agreement says about how cash flow should be distributed.
Hope this is helpful.
To help you out.
There are many types of construction lenders, not just debt funds. Banks, LifeCo's etc
There are many types of lenders that give permanent financing, not just LifeCo's. Banks(BB/Regional/Local), CMBS, Etc
Thanks, this is very helpful. Could I sent you the model and my solution to it, and maybe you could tell me if what I'm doing seems like the right way to approach it?
Where would be a good place to send it?
Edit: Oh you said to pm it. Okay I'll do that once I've finished my attempt at modeling it, I appreciate i
Set the construction loan to be paid off with the proceeds of the refinance. Yes the waterfall will use levered cash flow
For simplicity's sake.
I am assuming you are using a model that only has years not months right? What ever the construction loan duration make a permanent loan start equal to the end of the duration.
Add a cash flow line for the permanent loan below the construction loan. Use the following 12 months(1-year) for the NOI. Make sure you use a DSCR of at least 1.25x of the forward NOI. (NOI/1.25) so your formula is =PV(4.25% rate, 30-year amortization, (NOI/1.25) payment, fv = 0) that will get you your loan amount
I'm probably not stating anything new here, but during construction you will have a higher interest rate due to the inherent risk related to development, and the loan itself is sized against the total project cost (Loan to Cost). Once a building is stabilized and producing cash-flow you would pay-off the construction loan with a perminant loan based on the market value of the income stream (Loan to Value). A perminant loan will be modeled to have a lower interest rate since it is producing cash and is seen as less risky.
On the modeling end what you need to do is make line items for capital events along with the amortization of the loan an example would be
New Loan Capital Events Current Loan Balance Interest Amort New Loan Balance Capital Events Payback
Loan Balance
Or something like that, basically just 2 extra lines for the Refi/Capital events.
Capital Events should be before the debt/draw lines. That way it is easier to get an unlevered cash flow upon sale.
The difference between construction loan interest and permanent debt financing isn't always that great...could range between .75-1.75 points...although the construction debt is typically based on a floating rate. The construction loan requires guarantees and a higher equity contribution. Plus the asset at delivery should be worth more than the development cost.
Depending on how in-depth the model/exercise might be...there could be a need to include financing costs along with the release of operation and interest reserve accounts as cash flow at the time of refinance. Otherwise...people have already answered your question.
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