Chapter 12: financial leverage

Preferred Equity

An investment in the ownership interest of a property, that is not a mortgage, with a preferred return that takes priority over other equity investors

Interest-only Loans

Borrower pays only interest

Prepayment Penalties, Yield Maintenance, Loan Lockouts

Mortgage terms that make it costly or impossible for a borrower to payoff or refinance a loan before the contract maturity date

Loan Underwriting

The Loan to Value Ratio (LTV) and Debt Service Coverage Ratio (DSCR) are two of the key elements of a loan underwriting. Although the maximum LTV and minimum DSCR levels vary with mortgage market conditions, Lenders are always more secure with a lower LTV and a higher DSCR

Convertible Mortgage

When the Lender has the right to Convert part or all of the Loan Principal to an Ownership Interest in the Property at a specified time

Mezzanine Loans

A Loan that is Secured by the Owner's Equity in a Property rather than by a Mortgage on the property itself. Usually requires an Inter-Creditor Agreement between the Mezzanine Lender and the First Mortgage Lender

Financial Leverage

Allows an investor to use less equity to acquired an investment, potentially achieve a higher leveraged return, and benefit from the deductibility of mortgage interest. Investors with limited equity or who desired a higher leveraged return may try to borrow at a higher LTV, but as the LTV increases, Risk increases

Sale-Leaseback

An alternate means of financing a property where the seller retains use of the property for the duration of the lease term. With a Repurchase Option in the lease, the Seller may regain Ownership of the Property in the future

Positive and Negative Leverage

Positive Leverage is when investment Returns are higher with Debt than without. Negative Leverage is when investment Returns are lower with Debt than without. With Positive Leverage, the higher the LTV, the higher will be the Leveraged Return. With Negative Leverage, the higher the LTV, the lower will be the leveraged Return

Participating Loans

The lender receives additional interest, based on a formula typically related to Gross Income, NOI, or Cash Flow, that is called a Participation or Equity Kicker but not an actual Ownership interest in the Property

Accrual or negative Amortizing Loans

when the Pay Rate on a Loan is less than the Accrual Rate (i.e. Interest Rate), there will be Negative Amortization and the Loan Balance will increase over time. Might be used when interest rates are high