Jack be Nimble Jack be Quick, Jack Jumped Over the Rising Interest Rates
My son's soccer coach runs him through a drill where he sets up cones randomly and has him "dribble" through them. He says your instincts have to handle the unpredictability of the defenders coming at you. Be ready to react by being nimble, handling defenders, obstacles, curve balls, whatever it is. It is a time to think on your feet. If not prepared, you will have to wait on the sidelines. Muscle memory will take over for those that put in the reps.
Buyers Are Having a Tough Time Closing
Jack be nimble, Jack be quick, Jack jumped over the rising interest rate. Right now, buyers and sellers are facing considerable challenges in closing deals, which stems from lending. While a deal may make sense once a buyer puts it under contract, lenders change term sheets, reduce proceeds, and raise the rate, leaving the buyers to scramble. But if you have the contingency plan and network in place, you aren't so much scrambling as you are pivoting. You're handling that defender, that obstacle, that curveball, and coming out on top. Charlie Sheen would say your winning.
It's an odd time for Fortress Federation. We have two properties under contract to sell. The only problem is we are only half the equation. We can assist the buyer in whatever way possible to find the necessary pieces to close. Still, ultimately the deal closing rests on their ability to be nimble and handle the defenders. We have been buyers, and thankfully we have closed. So how have we pivoted or adjusted to be successful? Other than being aligned with some experienced and talented partners, here are some examples.
A "Re-trade" is Defensible in this Environment
"Re-trade" can be a bad word or term when purchasing real estate. A re-trade is a renegotiation of the terms of the sale. If a buyer tries to nickel and dime a seller over some insignificant items disclosed correctly, that buyer may risk losing the deal. They may also risk their reputation in the community. During these recent times, sellers can understand if a deal no longer pencils for the buyer due to an uptick in the cost of borrowing. As buyers, we had to return to the bargaining table in two cases. In each case, we negotiated justifiable discounts, allowing us to close our purchase and ultimately resulting in better projections for investors.
Going Partial Recourse Can Help Your Terms
One tactic we used, which can also be polarizing, is deciding to go partial recourse, which means the partners, myself included, agree to be personally liable for the loan (partially). Most every loan you see in large multifamily is non-recourse, meaning the buyer is not personally liable, and the lender takes on most of the risk to the tune of 75% to 80% LTV (loan to value). This is why the lender sits at the bottom of the capital stack (the first to get paid). We take some risk off the table for the lender and rid themselves of their cold feet (that nearly squashed a deal) by going partial recourse. Now that they have less risk, they are more willing to adjust terms. In our case, we received a lower spread (effectively lowering the interest rate) and more proceeds (which improves returns).
Do You Have to Have a Rate Cap? Not Necessarily
An interest rate cap limits how high an interest rate can rise on variable-rate debt. Interest rate caps are commonly used in variable-rate mortgages, specifically adjustable-rate mortgage (ARM) loans. Our most significant win was the lender allowing us to escrow a reserve to cover potential shortfalls (due to interest rate spikes) instead of being forced to purchase a rate cap.
A rate cap is a sunk cost; it's money gone. With a reserve equivalent to the rate cap amount (as agreed to by the lender), there is a strong potential that money could be returned to investors, which also improves returns.
And if you can hold the fort, you could see a deal improve over escrow, as has been the case with two of our deals. We already hit Pro-forma rents without so much as replacing a roll of toilet paper.
We're not out of the woods (this lending environment) yet. We are undoubtedly going to need to dribble around a few more cones. We embrace the challenge because, newsflash – multifamily isn't going anywhere. If we can get into good deals and project the "cones" out in front of us, it will have a happy ending. Possibly in the form of some attractive future refinancing.