Hi all,
I've been working on my some of my modelling skills and I have a quick question regarding the payment/financing of debt fees.
As a bit of background, I am currently working as an analyst in an investment sales team at a large consultancy. My role involves some modelling (although I have put a lot of work on the side to increase my knowledge) but as anyone who may have gone down the same route as me may know/have experienced, you tend to get dragged into a lot of boring side jobs that are less finance-heavy (ie research, data collection, market intel etc etc).
So, coming back round to the question.... and apologies in advance if my terminology is off
I largely understand how professional fees are treated, in that they just require extra equity but while I know how to generally model debt, I have no idea how fees related to debt are actually paid, and this lack of understanding isn't allowing me to fully understand the models.
For example, assuming a $100m property with 60% LTV - $40m of equity is required and the remaining $60m is provided through a senior loan. If that debt comes with a 1% origination fee, how exactly does this $600,000 get paid?
If the $600,000 comes out of the $40m equity, does that therefore not leave you short on the money required to purchase the building?
As such, when it boils down to it, how much of this deal would be debt and how much of it would be equity?
Most all of the time, any fees or points associated with the debt will come out of loan proceeds. There are a million ways someone patches up the difference from loan proceeds/purchase price though.
In my models I generally size the debt with closing costs/capex included, but without the origination fee/financing costs (i.e. In your case the equity req'd would be $40.6mm)
On development deals though, I capitalize all financing costs along with interest and haven't had a lender push back on that.
Easiest way to understand this is to create a sources and uses table (most people forget this). Sources of cash need to equal uses of cash.
Sources: Equity - $40 Debt - $60m x - $0.6m
Uses: Property - $100m Origination fee - $0.6m
The origination fee of $0.6m gets tricky. If you use the debt to cover the fee, then you will need to raise $60.6m. BUT that means the origination fee is now $0.606m, which means you actually need to raise $60.606m, which raises your origination fee... Notice the circular error?
In most cases, particularly in PE (or what I see in corp dev), you will need to bump the equity to cover this $0.6mm.
Sources: Equity - $40.6m Debt - $60m
Uses: Property - $100m O Fee - $0.6m
The other common way to make up the $0.6m is by obtaining a separate line of credit / term loan with a bank. You'll draw on this LOC to pay the $0.6m.
Sources: Equity - $40m Debt - $60m LOC - $0.6m
Uses: Property - $100m O Fee - $0.6m
I would avoid using the actual "debt" item to cover its own orig fee.
The origination fee doesn't always get funded by debt. If you are lending on a ground-up deal, and at the time of closing the equity has not fully gone into the project AND loan interest expense is future funded rather than having a reserve then equity will fund the fee.
You should also get yourself familiar with the interest reserve a lender will hold back within loan proceeds. Borrowers always under budget our IR. I'd start at a .5% or 1% minimum index (plus the loan spread) with semi annual increases of 50bps up to a maximum increase, like 150-200bps larger.
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