CO-OP
UPDATE
Challenges and Solutions:
Long -term Financing for Co-op Corporations and Multi-Family Borrowers
By
Gregg Winter, President
Winter & Company Commercial Real Estate Finance
During
the last year or so while
interest rates have been
at their lowest point in
decades, and as of this writing
in November
2003 rates have again dropped to near-historic levels for 30-year
fixed-rate co-op underlying mortgages and apartment building
loans. Even in the wake of the
rapid run-up in rates during July 2003, many co-op boards and owners
of multi-family properties are weighing the pros and cons of locking
in the rate on their new mortgage for 15 or even 30 years (rather
than the more typical 5 or 10 years).
There are typically seven people on a co-op board, and after 14
years of attending board meetings and working through the various
issues with co-op boards, I can certainly report that the debate
over whether to choose a 5 or 10-year mortgage vs. a 15 or 30-year
mortgage
is one of the most contentious that you will ever see. It is a
decision where only certain empirical pieces of information are
available (i.e.,
no one knows where
rates will be in 10 or 15 years when a balloon would need to be
refinanced, etc.), and emotions tend to run high over the inevitable
questions
faced by the borrower:
1.
Do we want the lowest possible
monthly payment on a shorter-term
loan (and then face a balloon
and an uncertain interest rate
environment),
Or
2.
Will we accept a slightly higher
monthly payment on a 30-year
fully amortizing loan knowing
that we will not ever face
a balloon payment and not have “the
rug pulled out from under us”?
Of
course there is no right or wrong
answer. Each borrower’s
needs and time frame are different.
Borrowers have different tolerances
for interest rate risk. The difference
in pricing between a 10-year
and a 30-year term will be between
60 and 75 basis points (as of
today
that might equate to 4.88% for the 10-year product and 5.5% for a
30-year fixed-rate mortgage).
Clearly the differences are very
real. There are, however, some
absolute guidelines for those
who choose to go with 15, 20,
25 or 30-year fixed rate financing:
The one inevitable rule of real estate is that money needs to be
spent to repair and improve it throughout the years. Roofs, windows,
pointing, boilers, hallways, lobbies, sidewalks, etc., will all need
renewal from time to time. This litany of typical real estate expenditures
is well known to both co-op boards and owners of apartments buildings.
So how can you lock in a 30-year fixed rate mortgage yet also be
prepared for
the
inevitable stream of expenses that will need to be faced in years
4, 12, 17 and 26? Presumably you either have a healthy reserve fund,
or you will borrow some extra money to establish one. However that
will only take you so far into the future. Certainly you can’t
put money aside now for the entire 30 years.
There are three critically important elements needed to successfully
structure long-term financing (meaning 15, 20, 25 or 30-year mortgages),
and to avoid feeling the need to refinance the entire mortgage part
of
the way through the loan term. The advice of a good commercial mortgage
broker can add significant value to achieving all three of these “add-ons”,
without which any borrower is likely to feel constrained as the years
go on and the need for additional borrowing inevitably arises. The
following should all be planned for and should be structured
into your loan documents when you refinance:
1. Get a well-priced credit line, unsecured if possible, to use
for short-term borrowing needs. (In New York State an unsecured
line will save you $27,500 in mortgage recording tax per million
borrowed). These credit facilities are typically for a period
of only 5 or 10 years, so a credit line alone will not adequately
address all your future needs.
2. Make absolutely sure that your lender can and will provide secondary
financing (second mortgages, third mortgages, etc.) during the
loan term. These facilities can, for example, provide a fixed-rate
second
mortgage in year 3 that will amortize over the remaining 27 years
of a 30-year loan term.
3. For 20, 25 or 30-year loans, structure them so that the prepayment
penalty (typically yield maintenance) will drop significantly after
a certain period of time. This will give you maximum flexibility
in the later years of the loan term if you decide to refinance.
These
three basic precautions are ESSENTIAL
when financing any co-op underlying
mortgage or multi-family property
for more than 5 or 10 years. The
longer the loan term, the more
carefully you must plan for the
future in choosing the lender and structuring and negotiating the loan
terms.
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