30-year Commercial Money? Yes!
W. Karl Baker, CPA
When discussing commercial financing needs with prospective clients, one of the first things we get asked all the time is “What’s the rate?” That depends on a lot of factors, such as property address, the borrower’s credit score, net cash flows from the lease agreement, leverage and a few other factors.
We also remind clients that “rate” is important but is not always the most important factor if cash flow is the goal. It’s certainly not the only factor to evaluate.
We also are asked, “What’s the term of your notes?” Many people are surprised that it is possible to obtain 30-year commercial money, especially if their only experience is what banks offer. So there’s usually a follow-up question when we tell them about our 30-year fixed rate commercial mortgages: “Is it really FIXED for 30 years, and it’s a commercial note?”, said with some astonishment! Our response is “YES! You really can get a 30-year fixed-rate commercial note!”
We advise clients to take a comprehensive approach to reviewing loan quotes from lenders.
Of course when all other factors are the same, the interest rate could make a big difference in your financing costs, monthly debt service, and net cash flows. The term of the loan also makes a big difference. All other things being equal, a 20-year note will have a higher payment than a 30-year note, which makes a big difference in cash flow.
When reviewing different scenarios, it is important to understand what your goals are when obtaining a financing. Is your goal to pay down debt as fast as possible? Achieve the absolutely lowest interest rate? Speed? High leverage and minimizing the down payment? Low hassle factor during the loan process?
Most investors we speak with are most concerned about getting the lowest payment moreso than paying debt down to zero on a cash-flowing property. The low payment funded by the property rents allows for a higher net operating cash flow to distribute to the investor, build up cash reserves and/or fund maintenance. While the interest rate is a contributing factor in the resultant payment, it is not the only factor.
That’s where loan terms and loan amortization comes in, as other contributing factors. The amortization period represents the number of years it will take to pay down a loan to zero with a fixed monthly payment. The longer the term, the lower the payment, all other factors being the same. Conversely, the shorter the term, the higher the payment, all other factors being the same.
For various legitimate reasons, most banks use a short-term fixed period, such as 5 years with a 15, 20, or 25-year amortization period. These debt structures are commonly a 5-year fixed rate loan, with the monthly payment computed “AS IF” it is a 20-year loan, for example. However, at the end of 5 years, there is a payment due equal to the beginning balance minus the amount of principal paid down from the monthly principal and interest payments. Additionally, some banks convert the note for a number of years after the first five-year period to a variable-interest loan tied to a market index.
By contrast, certain mortgage lenders, including us, offer a 30-year amortized commercial loan, offered as either a 30-year fixed rate mortgage or a shorter fixed term, such as 10 years, with 30-year amortization.
The longer amortization period results in a lower payment, which means the borrower’s net cash flow is higher. If a borrower’s goal is to pay down the debt to zero as quickly as possible, then the borrower should choose the loan with shorter amortization. However, if the goal is to maximize cash flow, the 30-year note is a great solution.
Let’s look at an example, assuming a $100,000 loan and an interest rate of 7.5%. The payment on a loan with a 20-year amortization and 5-year fixed period would be $805.59. At the end of 60 months, the borrower would have a loan balance of $86,902.10. That balance would need to be paid at the end of 60 months by either a cash payment from the borrower, or more commonly the loan is refinanced into another loan. That large balance due is called a “balloon payment”.
By contrast, if the borrower were to obtain that same $100,000 loan with the same interest rate of 7.5% but at a 30-year fixed period, the monthly payment would be $699.21 and no refinancing would ever be required, although, in a declining interest rate environment, there would be advantages to refinancing. That payment difference is $106.38, a 13% net cash flow savings. That’s the power of a 30-year financing. These are small absolute dollars, but imagine how those differences play out in a multi-million loan. The cash flow savings can add up quickly!
In our example, a rate of approximately 9.01% would result in the equivalent payment of $805.59 for a 30-year amortized loan. This means that the borrower would still enjoy cash flow savings with a 30-year fixed rate as long as the rate remains between 7.5% and 9.01%.
We trust this clarifies why rate may not always be the most important factor when structuring a financing. The term and amortization materially impact an investor’s cash flow and a 30-year mortgage can make a successful deal even more successful.
Additionally, in this current rising interest rate environment, a borrower could mitigate the cash flow impact of rising rates by choosing a 30-year fixed rate commercial note. We have said it before and will say it again (not to mention we’re hearing other investor influencers say), “Don’t wait to buy real estate; buy real estate and wait.”
Investors in the residential space are paying attention to the home price market. Home prices will start to fall soon due to market pressures, and we’re hearing of that already happening in certain markets across the country. Declining prices will be a permanent savings for an investor whereas interest rates will EVENTUAlly decline. Buying “low” will make a permanent impact on your portfolio and interest rates are only temporarily impacting the portfolio. Therefore, it will be a great time to build up the portfolio. Couple that opportunity with 30-year money, and your growth will accelerate! We wish you great success!
Please reach out to us if you have questions. You can start with info@InfinityCommCapital.com, 617-386-7127 or you can reach our current team at the following page: https://infinitycommcapital.com/about-us/.