Chapter 12 Financial Leverage / Financing Alternatives

Mezzanine Loan

A Loan that is often 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 acquire an Investment, potentially achieve a higher Leveraged Return on Equity, and benefit from the Tax Deductibility of Mortgage Interest. Investors who desire a higher Leveraged Return on Equity might borrow at a higher LTV ratio, but as the LTV increases, Risk increases.

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.

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 reacquire Ownership of the Property in the future.

Interest-Only Loan

Borrower pays only Interest on the Loan, with no Principal Amortization, and a Balloon Payment due at Maturity. Also called a "Bullet Loan".

Prepayment Penalties, Yield Maintenance, Loan Lockouts

Mortgage Loan terms that make it costly or impossible for a Borrower to Payoff or Refinance a Loan before the contract Maturity Date.

Positive and Negative Leverage

Positive Leverage is when the Return on Equity is higher with Debt than without, and Negative Leverage is when the Return on Equity is lower with Debt than without. With Positive Leverage, the higher the LTV ratio, the higher will be the Leveraged Return on Equity. With Negative Leverage, the higher the LTV ratio, the lower will be the Leveraged Return on Equity.

Participating Loan

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 the Lender does not have any Ownership Interest in the Property.

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 ratio and minimum DSCR levels vary with Mortgage Market conditions, Lenders are always more secure with a lower LTV ratio 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.

Negative Amortizing Loan

When the Payment Rate on a Loan is less than the Accrual Rate (i.e. Interest amount then due), there will be Negative Amortization and the Loan Balance will increase. Might be used when Interest Rates are very high.