Interview Question - What property would you use debt for
For what property would you be more inclined/likely to use debt - a multifamily property or a four tenant industrial property. Please explain your reasoning. Was recently asked this in an interview.
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This sounds like a trick question. Some amount of debt is almost always used for commercial real estate.
Gotta be one of the most vague questions I've seen. What's the current condition of the properties? where are they located? what are their current levels of vacancy/occupancy? what's the investment objective of the investor?
Maybe it's designed for you to ask these types of questions
Can you explain further the factors that would lead you to choose either office or industrial? Someone told me that you would use more debt for an industrial property because theres a high demand for them so theres more certainty in cash flows.
Follow the advice of Lucky and CRE. It's a BS question, you would almost always use debt, and Lucky is probably right that the question may be designed for you to ask those questions above.
The amount of leverage isn't so much dictated by property type, as appetite for risk and metrics such as NOI, debt service coverage ratio, and debt yield. (and again, Lucky's questions)
Tell that interviewer man that you would use debt on all properties. End it with "lever the fuck up" and slam your fist on the table assertively.
Definitely sounds like a trick question. There are so many other factors you'd need to know in order to conclude debt is better suited for one property type but not the other. You'd need to ask questions similar to what Lucky Luciano posted.
I'd put debt on the four tenant industrial. Multi tenant isn't as attractive as single tenant industrial, so I'd aim to put 70% or more debt on it and just lever up the returns, and hedge against not having credit tenants in-place.
If it's class A multifamily you will most likely have plenty of all cash offers and maybe even some lunatic fronting significant earnest money to win the deal. Having to secure debt - albeit it wouldn't be difficult - may hinder your chances.
@MPBYO Not to be argumentative, but for the very reason that four tenant industrial would be viewed as less attractive to prospective tenants, wouldn't you want to put less debt on it? If you overleverage on a "riskier" asset and can't make your payments you aren't in a good situation either.
On my side, I'd rather lend on a multifamily asset where one tenant vacating doesn't create a significant shortfall in EGI until that unit is leased up. Multifamily typically has a shorter (if any) downtime - depending on location of course and usually more units making it a more secure source of income and repayment.
That's the beauty of non recourse debt. If you are going to enter into a risky investment, you can use non recourse to cover your ass and mail they keys into the lender if things go bad.
If you lever up a class A MF property at 50%LTV, assuming you purchase the asset at a 4.50% cap, hold for 10 years, you are looking at a levered IRR of around 7.50 - 8%
With 75% LTV on the multi industrial you can get the IRR north of 10%
There are a lot of conclusions that can be reached from this question.
Good practical points above, but I think the point of the question is obvious. The interviewer is trying to suss out that you know debt is less appropriate for riskier properties, and then how you would think through whether a multi-family or a 4-tenant industrial is a riskier property.
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