Let's talk refi assumptions

Trying to understand the concept a bit more, as I have limited refi modeling experience.

For example, let's say you buy a property at $100m and lever up 50% floating I/O. After 5 years, you plan to refi your $50m outstanding balance through a fixed/amortizing loan. I can see this being modeled the following way:

Figure out your property value at year 6 and what LTV you could get based on the market. Construct a yield curve to determine what interest rates will be at that time. Your refi BB at year 6 would still be $50m, but your payments going forward would reflect the new loan. Additionally, if your property value has increased you'd most likely have access to tax deferred cash proceeds which would be tacked onto your cash flow in that year.

My questions:
1) Is the above method reflective of what you all do when underwriting a refi?
2) What method do you use when projecting your property value at refi time? Direct cap based on NOI?
3) It's possible that property values could fall by refi time, which would result in an out of pocket payment or a decision to delay your refi or not refi at all. Do you take that into account when underwriting, or is that something that is done when it's closer to refi time by the Asset Management/portfolio management team?

4) Am I understanding refi proceeds correctly?

Comments (2)

Best Response
Feb 7, 2016

You definitely have an understanding of the core concepts surrounding refis. Regarding the future valuation for your property, you can derive the valuation by utilizing the direct cap approach. You should come up with income and expense growth rates (probably in the 2-4% range) in order to project the NOI at the time of refi. A general rule of the thumb regarding the future cap rates is to add 50-100 BPs to the going-in cap. However, you obviously need to evaluate the specific characteristics of your property and the submarket it is in (demographics, supply/demand factor, occupancy, etc.) in order to truly determine potential cap rate 5 years down the line.

From an equity perspective, you would project out your year 6's NOI and come up with an exit cap in order to determine the projected sale price of your property at the end of Year 5. However, many lenders utilize the in-place NOI when utilizing the direct cap approach rather than looking at the first year's NOI. Regarding the tax deferred cash proceeds you mentioned, I've seen much activity in the cash-out refi space recently (I work a lot with multi-family Manhattan properties) with sellers choosing to cash-out refi rather than do a 1031 Exchange due to these sellers' lack of desire to exchange into a property they know will be commanding such a high premium.

Regarding a potential decrease in property value at the time of refi, there is still the possibility that no cash needs to come out of pocket. You mentioned attaining an I/O loan with a 50% LTV. Even if the property loses some value, you can potentially refi at a higher LTV (75% range) which would more than offset the in-place loan assuming your property doesn't lose >25% of its value. With that being said, while a well thoughout, dynamic model can paint a good image for you, the Asset Management team would most likely spearhead the refi and disposition process, making their decision based on a wide array of conditions at the time of refi (health of capital markets, condition of your property's submarket, condition of the real estate market as a whole, etc.)

For multi-family developments models I've worked on, I take the lessor of a 75% LTV and a 1.25 DSCR in order to determine the permanent financing I can attain.

Hope this helps.

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Apr 22, 2016