Debt or Acquisition Folk - How do you think through what type of debt (Conduit, LifeCo, Debt Fund, Balance Sheet) to place on your acquisition? While this applies to all product types, I imagine it's more relevant on Office deals given the increased risks (vacancy, lease-up, capex) of the deal. Specifically thinking how you consider the following:
- Term
- Leverage
- Fixed/Floating
- I/O vs Ammo
- Future Funding
- Flexibility to Prepay
Equally as interest to how people who work in debt view these things.
Ask a debt broker, they're usually the best to answer this stuff and most of them are desperate enough for deals they'll fill you in. But really I think the deal dictates the debt as much as anything.
In initial underwriting this is how I approach it:
1) If it's value add how long does that take to complete? Where's my rollover exposure and where is my refinance risk highest.
2) we usually just go high non-recourse option here, or recourse with a burn-off. That usually removes Life Co
3). My previous employer always did floating, because they thought rates weren't going up anytime soon. Not sure if they changed this in the past two years, but with the antiicpation of rising rates I imagine more ppl are moving to fixed. Again on value add depnds how far out for refinance
4). My principal only looks at cash on cash, so I will trade anything for I/O to trick him into thinking a deal is better year one.
5).. Conduit limits your ability here, balance sheet I think is probably the best for this, but someone else may have better insight
6). On conduit we've taken the stance that rates may go up reducing some of the defeasance costs. Want to have no prepays by the time we plan to refinance, will take shorter term to accomplish that if neccesary.
In general;
LifeCos are gonna have the lowest rates though many tend to target the "trophy" assets or lower leverage deals. Prepayment is typically one-way make whole ("Yield Maintenance")
CMBS will offer higher leverage on non-recourse terms but are not very flexible for scenarios that require something like partial release, future earn-outs, etc. Prepayment is typically Defeasance.
Banks (Wells, JPM, etc.) tend to offer more flexibility for value-add deals, partial releases, earn-outs etc. and may get to Non-Recourse depending on overall credit metrics. If there is risk in getting stabilized or possible future de-stabilizing( like large tenant rollover during loan tenor) they may require some limited recourse. Fixed rates are often synthetic and pre-payment becomes two-way make-whole (i.e. rates go up and you get paid to cancel the swap).
As far as IO goes, as a balance sheet lender we often get to full-term IO but its based on an exit test at the balloon balance and a couple of assumptions about future NOI. I may be mistaken, but i believe you could probably do the same with just about any type of lender, provided you go in low enough to pass their refi test on the back end???