Holdbacks and Reserves
How much does everyone underwrite to? E.G. if you have a 10-year hold period and 3-year I/O do most people for vanilla, single, stablized assets. Let's say you want the I/O to get more in loan proceeds but in year 3 you have a DSCR of .99x (year 1&2 are 1.25x and 1.05 respectively), and then after year-4 it does steadily upward. What amount would lender's hold back? Do they look at first year DSCR, AVG DSCR or min DSCR? Or would they decrease the loan amount to an avg or min dscr over 10-year hold period?
Trying to figure out if there is a rule of thumb, and when it is capitalized as I have done it that way but just the amount my director wanted; no explanation?
Well what's the play? Some kind of value add? And what product type? I've done some multi deals where we may be 50% occupied at some point, so we capitalized a shit ton of working cap
Just re-read. For a stabilized asset they are gonna underwrite to a trailing 12 1.25 generally. Why, in ur example, would ur dscr drop in a stabilized asset in yr 2?
good catch, 2-year I/O with 1.25 and 1.29 DSCR then year 3 it drops to .99x DSCR when 30-yr amort kicks in.
Then it slowly increases to year 10 DSCR at 1.25x. Now regardless of whether this works from an equity perspective on acquisistion, maybe we can call it a max-cashout refi.
What would be the holdback for the lender? Would it be a lower LTV at the expense of a higher dscr?
Yeah honestly I think it'd be lower LTV. Cus they'd see that once ur I/O ran out you'd be below a 1.25. On a stabilized asset I don't see why they'd ever lend up to an amount where u couldn't cover by 1.25. I mean maybe u could get 1.1. But ur splitting hairs at that point
Yeah thought about that. I should say caveat is Manhattan times square real estate, 30mm total refi, maybe 9mm cashout. This is a tight market and chasing this deal with so many brokers becomes a well "he got me 100,00k more".
So are you saying that every year of a 10-year proforma must be above a 1.25x DSCR? Is there an average over 10-years, is there a min over 10-years? Would a lender holback proceeds to nominally say yeah it's a 30mm cashout but we are holding back 2 mil...for... projected loss in revenue?
Yeah I hear you. So it's basically class A+ super fuckin stabilized asset. Congrats btw on the cash out (I love refis). But I'd say the min coverage you could get away with is like 1.1. They'll assess you on a quarterly or maybe annual basis. Cus if your already cashin out that much they aren't gonna let you get levered to the point were you couldn't cover. B/c if ur already stabilized, only chance for noi growth is market rent growth.
Also depends on how much of that cash out is profit. We just refid out our equity on a deal and then some, and we had a lot of trouble getting lenders over the hump on how much we were taking off the table.
Can someone help me understand the proper use of a holdback in this situation (and in general)? Is it for situations where CF is projected to fall below the DSCR test for a year or two, and therefore, the Lender uses it to temporarily lower LTV and consequently the debt service (and then after CF rises enough to meet the test, the holdback is released, increasing the LTV)? Is it the same as an earn out in that sense?
Also, how do Lenders think about this versus using, say, an interest reserve?
The many different reserves and holdbacks have confused me as I'm u/w deals and I'd really appreciate someone providing a dumbed-down version on when each type of reserve/holdback is appropriate and how they all work with one another.
Most balance sheet lenders would size the loan to a minimum 1.20/1.25 DSCR amortizing (year 1) based on current interest rates. When interest rates were higher (coupons of 6-7%) loans would be sized to a 1.10x amortizing DSCR. Exit testing is definitely considered by most lenders now because current interest rates are so low and everyone knows that it isn't going to stay that way. My shop uses a 7.5% coupon to test for exit..
In CMBS world, minimum amortizing year 1 DSCR of 1.20x is still pretty common, but exit tests are usually DY (the better the asset, the lower the DY that they will allow).
You shouldn't be seeing higher proceeds because of the IO. If anything, you should be seeing lower proceeds. IO lets the borrower skim cash in the most predictable years. Lenders are protectionists (mostly, there are loan to own lenders out there too), so they generally aren't going to let the borrower skim all the cash and then screw them over.
The difference in proceeds is probably more related to what the originator thinks the value of he property is. Lender 1 thinks it is 30 million, Lender 2 thinks it is 31 million and gives you a loan reflecting that.
Quick primer on reserves/hold backs: Rollover reserves: can be springing or upfront. Upfront could be something like: borrower deposits 50k/month every month for the term of the loan/until they reach a certain threshold. Springing are usually tenant specific: XYZ tenant makes up 40% of you building and has a rollover in year 7. The notice provision is 12 months. Starting 18 months prior to expiration, borrower will deposit 1/18 of the amount estimates for TIs/LCs if the tenant were to vacate (these amounts are calcualted at loan closing). If the tenant renews, then the borrower gets their money back (usually there are conditions on this; TIs/LCs for new lease must be paid, tenant must be paying rent). Sometimes springing reserves will be capped too (e.g. Only have to fund 5 million of the 10 million necessary for TIs/LCs for the potentially rolling tenant).
Tax/insurance reserves are pretty self explanatory, but what most people don't realize is that they are generally funded to 120% of the payment amounts. So if taxes are 1 million, monthly escrow would be 100k (100k X 12 = 1.2 million).
Hold backs could be for any number of reasons. TI/LC holdback: you just signed a huge lease with XYZ tenant. You want full proceeds on a new loan, but have significant outstanding TIs/LCs owed to XYZ. Until they are paid, they can terminate the lease (which is common). Lender will holdback the owed amounts to ensure they get paid and tenant starts paying rent. The value of the property is mostly tied to that tenant paying rent, so the lender isn't going to give the borrower the ability to just pocket the cash and then give the property back.
Free rent holdbacks are the same as a TI/LC except for free rent periods. The lender usually puts $ into the reserve at closing and then will use it to pay themselves during the tenants free rent period. This is how you can get a loan with a current DSCR of 0.95x, but projected DSCR of 1.20x when free rent burns off.
There are also hold backs for major capital items (new roofs in year 2, window replacement, etc.)
Also, there can be holdbacks for properties that are in lease-up. The property is 80% leased, so you get 80% of the $ for the loan. Once you reach stabilization, you get the rest. Many do this because a lot of lenders won't "top off" loans. So they are basically pre committing to the "earn out", but as borrower, you are paying interest on the full committed amount, so you better lease up the building as planned.
SB for you. Thanks for the write-up.
Is the difference between an earn out and holdback reserve the fact that the Borrower pays interest on the holdback dollars before they are drawn, as opposed to earn outs where you only pay interest on the capital drawn to date?
Yes. Holdbacks/reserves are funded at closing whereas earn outs/good news money is usually committed, but not funded at closing.
Good lord. Another thread about loan sizing and stressed DSCR. Underwrite using debt yield. Please.
Yeah, I'll get right on that....when CMBS actually wins a multifamily deal in nyc. ;)
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