Chapter 12 Financial Leverage & Financing Alternatives

Yield Maintenance Fee (YMF)

A fee where the lender is able to charge a penalty for prepayment. This period is between the lockout but before the maturity.

Covenants (in mortgage agreement)

A list of shit that lenders may need to approve of before the borrower does or that borrowers agree to supply.

Sale-leaseback of land

A transaction in which the owner of a property sells an asset, typically real estate, and then leases it back from the buyer. In this way the transaction functions as a loan, with payments taking the form of rent.

Mezzanine Loan

An alternative to a 2nd mortgage. This loan bridges the gap between the first mortgage debt on the property and the equity investment. Secured through investor equity, not the property (unlike a 2nd mortgage).

Loan-to-value Ratio

An important figure in underwriting. 80% and greater is very risky.

Bullet Loans

Any loan that requires a balloon payment at the end of the term and anticipates that the loan will be refinanced in order to meet the balloon payment obligation.

Put Option

From the borrowers perspective a Non-recourse Clause can be seen as a put.

Convertible Mortgages

Gives the lender an option to purchase a full or partial interest in the property at the end of some specified period of time. This purchase option allows the lender to convert its mortgage to equity ownership. Kinda like a call option.

Debt Coverage Ratio

Important ratio in underwriting analysis. DCR = NOI vs. DS (debt sevice) Lenders like to see this as at least 1.20

Preferred Equity

In addition to regular/common equity, an equity interest in the property but has debt like characteristics, similar to preferred shareholders.

Equity Participation Loans

In return for a lower stated interest rate on the loan, the lender participates in some way in the income or cash flow from the property. Thus, the lenders rater of return depends on the performance of the property.

Incremental Cost of Debt

Increase in total costs resulting from an increase in production or other activity.

Pay Rate

Loan payments are sometimes calculated using a rate to calculate the loan payment. This is different from the rate used to calculate the interest charged (the accrual rate).

Interest-only Loan

No amortization occurs. Only debt service. Balance does not change. At the end of the interest-only the loan may change to an amortizing loan or all be due (ballon).

Accrual Loans

Non-performing loan on which interest is overdue and full collection of principal is uncertain. Negative amortizing too.

Lockout Period

Period that the lockout clause exists. Usually 7-10 years.

Lockout Clause

Prohibits the borrower from prepaying the loan within a specific period of time (usually 7 to 10 years). It is used because if the borrower were to sell the property or refinance within the lockout period, the lender would receive the funds earlier than anticipated and face the prospect of having to reloan such funds at an interest rate that may be lower than the rate at which the loan was made.

Non-recourse Clause

Put in the note. Makes the property the sole source of security for the loan. Requires a higher fee or interest rate. Can be viewed as a put option from the borrowers standpoint.

Financial Leverage

The benefits that may result for an investor who borrows money at a rate of interest lower than the expected return on total funds invested in a property. 3 Reasons: 1) Don't have enough funds 2) Tax benefits 3) Possible greater return

Break-even Interest Rate

The maximum interest rate that can be paid on the debt before the leverage becomes unfavorable. BTIRR(effective cost)= ATIRR(on total funds) / (1-tax) ETR = Total return / (1-t)

Balloon Payment

The payment (entire initial balance, didn't change) of a a loan after there was no amortization.

Accrual Rate

Used to calculate the interest charged

Negative (unfavorable) Financial Leverage

When debt is more expensive than the return. The use of more debt will magnify losses of equity invested in the property.

Positive (favorable) Financial Leverage

When the BTIRR and ATIRR is greater with debt as opposed to 100% equity.

Negative Amoritization

When there is a shortfall in payment (because the loan uses a pay rate with no amortization) and the pay rate is lower than the accrual rate, a loan payment that is less than the amount of interest due on the outstanding balance results in this. Causes loan balance to increase.