Rational behind a lender choosing a loan term

Debt Folks, have a question- Is there a science behind the loan term chosen by the lenders? For example, a deal I am involved with is a single tenant industrial deal where there are four years left in the lease. Tenant is B+ rated tenant, solid tenant. Will any lender be willing to lend on a long term 5, 7 or 10 year term? Or is the only option a short term 2 year bridge loan and once it gets stabilized with a longer term lease, then refinance with a longer term loan? I have a 2 year loan term quote from a national bank, so I was wondering whats the reasoning that goes behind a lender choosing a a 2 year loan vs 5 or 7 years? Because even with a 2 year loan, there is a chance that the tenant does not renew the lease and there is not a lot of interest from lenders wanting to refinance this loan at the 3rd year with the tenant not renewing, so why a 2 yr loan and not a longer term loan? I am failing to see how the lender is minimizing risk by offering a 2 yr loan. I was thinking a 5, 7 or 10 year loan with reserves held back for a possible shortfall in year 3 or 4 can still be worthwhile for a lender. Thank you for any help, appreciate it!

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Comments (17)

May 19, 2018

so they typically are hesitant to lend because of the following risks. Its single tenant, so if the tenant doesnt renew, who will absorb the location? how long will that take? will the borrower have money to pay the debt payment if his property isnt cash flowing? also, what is the go dark value of this property? how much is this tenant paying, and is that under market, above market, or at market? Doing short term financing make sense in this case because this is a tenant with a credit rating and lease in place. The tenant renews? great, the lender will take out the bridge and slap some permanent long term financing. tenant doesnt renew? great, we will still make our money and get out. reserves captured in the 2 years likely wont cover the full debt service for another 3 years if they do a 5 year term. let me know if you want me to expand on something.

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May 19, 2018

Thank you! Appreciate it! One thing I still dont get is that if the tenant does not renew, there is still a refinance/balloon payment risk as many lenders may be unwilling to take out the loan without a tenant in place, so even with a 2 year loan, there is risk for the lender, so in this worst case scenario, is there a reason 2 years makes it better than say 5 or 7? Because I see a refinance/balloon payment payment risk either way if the tenant does not renew whether its a 2yr or a 5 yr loan. Appreciate any insight.

Jan 8, 2019

bumping this as I think its a valid question. @Chekdastack how would you remedy the baloon payment without structure?

May 19, 2018

is this recourse or non recourse?

May 19, 2018

non recourse with standard bad boy carveouts.

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May 19, 2018

hmmm. is the ltv under 50%? whats the amortization like?

May 19, 2018

LTV is 65%, 30 yr amort. Libor plus 250. The 2 yr loan is structured as a 1 year loan with two-6 month extensions. The pitch from the lender is that if the tenant renews or if a new long term lease is signed, they will take out the loan themselves using a CMBS loan and waive the exit fee.

May 19, 2018

wow. not really sure how they are structuring this with so much uncertainty. cant think of anything else tbh.

May 19, 2018

I went through this in 2015 with a very reputable regional tenant (105 locations and they own 20 of their stores free and clear). My client has leases on two buildings expiring in 2yr and 4yrs. To get the deal done we had to structure new leases to 8yrs and 10yrs. Even with this scenario and the tenant being very solid we only got 15yr AM 5yr balloon.

Single tenant financing is tough sometimes. This was in WI and over there $2mil is big loan to a bank with only 3 branches.

The good news is that in 12 years my client will probably have two free and clear NNN deals grossing 300k a year.

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May 19, 2018

gotcha thank you! 5yr is still decent, we have a quote for only 2 years right now. Curious, given the balloon payment risk whether it's a 2 or a 5 yr loan, is there any reason why a lender would prefer a shorter 2 year term? Does that minimize risk in any way?

Most Helpful
May 19, 2018

Yes it does. It gives them two years to put pressure on the landlord and tenant to strike a deal. They control any extensions. Even if your DOT has built in extensions, they lender can totally kill those btw. So, they may have three years now to force a scenario where they can land a longer lease and refi the deal.

Also, gotta keep the auditors/regulators happy. And if it's commercial (which it is) vs multifamily, it has larger reserve requirements. So, as strong as your tenant is, banks have to keep an eye on their balance sheet.

I talk with my bankers on the regular about how they think and why their LOI is what it is. A regional lender here in SoCal is pursuing low income/section 8 apartment deals because of some shit called CRA. Never heard of it cause I'm not a banker. Anyway...brought them a 3.5mil apartment purchase, 16 units and 11 are Section 8 (subsidized). They want the loan because it shows that they're not "redlining" or "black-balling" certain neighborhoods and/or demographics. Apparently they have to report this stuff to the regulators and meet certain metrics.

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May 21, 2018
PacNumber:

Yes it does. It gives them two years to put pressure on the landlord and tenant to strike a deal. They control any extensions. Even if your DOT has built in extensions, they lender can totally kill those btw. So, they may have three years now to force a scenario where they can land a longer lease and refi the deal.

Also, gotta keep the auditors/regulators happy. And if it's commercial (which it is) vs multifamily, it has larger reserve requirements. So, as strong as your tenant is, banks have to keep an eye on their balance sheet.

I talk with my bankers on the regular about how they think and why their LOI is what it is. A regional lender here in SoCal is pursuing low income/section 8 apartment deals because of some shit called CRA. Never heard of it cause I'm not a banker. Anyway...brought them a 3.5mil apartment purchase, 16 units and 11 are Section 8 (subsidized). They want the loan because it shows that they're not "redlining" or "black-balling" certain neighborhoods and/or demographics. Apparently they have to report this stuff to the regulators and meet certain metrics.

I don't know why, but I find this hilarious

May 19, 2018

I've seen it first hand, lol. In CA the lender can boot a commercial tenant upon foreclosure. They hold all the cards.

May 20, 2018

Terms are usually based upon rollover/exit metrics.

The theory behind a 2 year loan is that when the loan matures, there will still be 2 years left on the lease. Generally speaking there will most likely be a bridge lender that will do the takeout, requiring structure for the rollover (either sweep the cash for the 2 years if that is enough to cover TI/LC costs, fund a reserve at closing or structure a hold-back/good-news money). That bridge money is going to be much more expensive than L+250.

You wouldn't do a 5 year because the exit is too risky. Even with reserves, if you figure 9 months of downtime between leases, your new lease would just be staring, TI/LCs would be due, and potentially free rent would all be happening at maturity. Unless you are loan-to-own, lenders don't make it a habit to structure themselves into a hole where they would have to do a modification/workout at maturity.

You might do a 7 year if you believed in the market/borrower. But this would require structure around the rollover. However, there isn't a whole lot of 7 year floating money available (most banks like to stay in the <5 year floating market unless it is an A+ asset).

And to play in the 7-10 year fixed market to get to some of the lifecos/balance sheet lenders, this deal would have to be 20+ million. You might be able to go CMBS, but single-tenant isn't exactly on the top of their wish list.

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May 20, 2018

Another thing that matters is the cost of capital. It's more expensive to lend longer term (5, 7-yr) than it is short term. Plus, when that tenant blows out and you have no income that loan ends up looking like its a high default risk, so the lender has to stash a lot of money aside for that scenario - making the loan suck wind.

May 22, 2018

A lot of good answers already, my two cents:
In 2 years there is an asset spitting cash flow for another two years. If you didn't re-gear the lease you are going to have to find some expensive ass financing (maybe they will charge you a lot more and finance you further on the deal). If worst comes to worse and you default because you can't find someone to take the loan - they have an asset with two years of cash flows left on it and they control for two years, had they been loaning on it they would only be repossessing in 4 years if the asset is vacant at that term.

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May 29, 2018