| Commercial Loan for Apartment Complex |
| Posted by: Michael Mar 12 2004, 10:53 AM |
| Hi, I’ve just finished construction on a new apartment complex consisting of 12 units. All the units are rented and product a mo income of 6,630. I have three different offers from lenders on a long term mortgage and wanted to get your opinion on each. I’m leaning toward the first one. *Offer 1 – this is the bank that gave me the construction loan and will roll it over into a long term mortgage with no additional fees or appraisals, etc…. 5yr adjustable @ 6.25% for a 20yr term on a 560,000 note. *Offer 2 – this is a competing local bank 5yr Balloon @ 5.95 for a 20yr term on a 560,000 note. + 1 point closing + Attorney fees + Appraisal *Offer 3 – this is through a mortgage broker 5yr adjustable @ 6.125% for a 25 yr term on a 560,000 note + .5% orgination fee + .750% financing fee + $500 application fee + 2,000 appraisal fee + 1500 legal feed + it also has a prepayment fee which allows 10% pre-payment per year without a penalty. The fees are Year 1(3%), Year 2(2.5%), Year 3(2%), Year4 (1.5%), Year (1%). It resets after 5yrs. Thanks for your help, This is an absolutely terrific site! It’s very educational! |
| Posted by: loanuniverse Mar 12 2004, 01:20 PM |
| Michael, the answer involves some math. I am kind of busy today at work, and will be out of reach tomorrow so expect the answer sometime Sunday. Unless, I need a mental break from work today and I decide to run the numbers. |
| Posted by: loanuniverse Mar 12 2004, 10:01 PM |
| Michael: I got home and the plans for tonight fell through so let me use some of my newfound free time to figure this out. Well there are a couple of things that you failed to mention such as the base rate that is going to be used for the repricing of the loans and what your holding period is going to be. I think I have done this kind of comparison for other visitors before, but the result has always been so clear that there was no need to do a “time value of money” analysis. In the prior comparisons one loan was clearly a better choice. In this situation, a little more work is required so there is going to be some math involved. For simplicity sake lets say that you intend to get rid of the property at the end of the five years. How do we approach this? Is all about cash flows. You have outgoing cash flows and incoming cash flows. The problem is that in order to compare them you need to take them down to a common denominator. This is what present value of money calculations do for you. I am going to do those calculations for you. They won’t be detailed calculations, and won’t be exact. {I am doing them annually when the cash flow should be done monthly, and the amortization is using the one in the website that uses a 365 day year, which will not be the one used for a commercial loan, but it will be close enough } We now do a couple of steps: We have to identify the cash flows that are common to all three options, as far as I can tell they are as follows: 1- An original outgoing cash flow in the form of closing costs. 2- An annual incoming cash flow resulting from the difference between the debt payments. 3- A final incoming cash flow in the form of any differences in amortization {this will come into play when we take a look at the 25 year amortization} Now we compare the options: *Offer 1 – 5yr adjustable @ 6.25% for a 20yr term on a 560,000 note. This is going to be our base case, we will choose another option if they have a higher present value than this one. Otherwise, we stick with it. Closing costs present value = $0 Difference in annual cash flows present value = $0 Difference in final value amortization discounted to the present = $0 5yr Balloon @ 5.95 for a 20yr term on a 560,000 note. This one has two different things from our base case. It has closing fees and a slightly lower payment. There are no significant differences in the remaining loan balance at the end of the fifth year so we disregard that. Closing costs present value = -$10,000 Difference in annual cash flows present value = $5,000 Difference in final value amortization discounted to the present = $0 Difference in present value is –$5,000. So far the first one still looks good. Now let me explain how I got the difference in annual cash flows present value: I took the sum of twelve payments for the first case and subtracted the sum of twelve payments from the second option. The second option has a lower rate so I am going to be getting more money from the rental operations every year {$1,188 to be exact}, but the money is being received over the five years of the loan so I have to discount it back to the present. I do that by using something called “present value of an annuity”. There are a couple of calculators free on the web so you do not need to know the formula. 5yr adjustable @ 6.125% for a 25 yr term on a 560,000 note This one has three different things from the base case and the calculations require an extra step. Closing costs present value = -$11,000 Difference in annual cash flows present value = $22,304 Difference in final value amortization discounted to the present = -$20,000 Difference in present value is –$8,696. It is now final, the best option is the base case! Now let me explain how I got the difference in final value amortization discounted to the present: While originally one might think that the third option is the best due to the lower monthly payment, you have to account for the fact that the 25 year amortization means that the principal will not be amortized as fast as the first two options. The difference is about $27,000, which you are going to have to repay in five years when you sell the property, but that also has to be discounted back. Remember that this is not exact, and the amounts will change a bit depending on the interest rate that you use to discount back {I used 6%}. Hope this helps. |
