Value Added Transactions Mastery Lesson 06

Lesson Six: Exit Strategy Overview: Exit Types for Bridge & Mezzanine Loans

Value added investments are fairly easy to get into, but much more difficult to get out of with profit. Anyone can make an investment, but the art of the business is structuring an investment with a defined exit strategy, a reasonable profit, the appropriate structure and debt and equity pricing that reflects the risk of the transaction. As was stated before, when analyzing a real estate investment, ALWAYS begin with the exit in mind. There are two exit strategies that we will explore in this lesson: Permanent Loan Refinance and Sale

6.1 Permanent Loan Refinance Exit

In value added real estate, the asset is not ready for sale or permanent financing because the asset is not yet stabilized. There is a “bet” that value can be increased by increasing the NOI. This means that an investment within the property is needed so the property earns more income. By investing money into the property, a greater return is made! With value added properties, the value added loan is typically higher leverage than the stabilized loan, and the value added loan typically is a higher rate than a stabilized loan. The reason behind these features is because the risk is greater since there are more unknowns than in stabilized properties.

  • 10-year Treasury rate or LIBOR
  • Spread, which is the difference between the interest rate and the benchmark (Treasury rate or LIBOR)
  • Loan amortization rate
  • Loan constant
  • Interest rate stress
  • If the investor is seeking a multiyear deal, then the interest rate needs to be stressed to protect the investor against a rise in rates during the hold period.

Permanent Loan Refinance Assumptions

In calculating the conduit loan, the lender might reduce the stabilized NOI to the “lender-underwritten NOI.” This latter number is based on the lender taking deductions against the NOI for future “bad events” that might occur at the property. Let’s take a look at an example.

Lender’s New NOI Calculation

The lender has reduced the $950,000 pro forma NOI to $775,500, or a decrease of 18.4%. This calculation provides a dose of reality on what might be spent on the property during the lender’s hold period. It also serves as an added safety cushion for the lender.

Once the conduit lender has reduced to NOI to their underwritten value, a loan is sized based on the new NOI. Let’s look at this analysis.

Refinance Exit-Strategy Analysis

6.2 Sale Exit

The other possible exit is the sale exit. Achieving a profit on a sale exit is typically more difficult. Thus, the sale exit is viewed as a secondary exit. In this exit strategy, the investor is looking to achieve a profit from the proceeds of the sale after paying the selling costs, and paying off the total loan amount.

Sales proceeds are driven by the cap rates. Cap rates are simply the rate of return that unleveraged buyers are willing to accept to own the asset. When analyzing a sale exit, you should use a cap rate sensitivity table. This will take into account the possible outcomes of a sale, based on cap rates at the time of the sale.

Sale Exit Cap-Rate Sensitivity Table

Assignment:

Value added investments are fairly easy to get into, but much more difficult to get out of with profit. Anyone can make an investment, but the art of the business is structuring an investment with a defined exit strategy, a reasonable profit, the appropriate structure and debt and equity pricing that reflects the risk of the transaction. As was stated before, when analyzing a real estate investment, ALWAYS begin with the exit in mind. There are two exit strategies that we will explore in this lesson: Permanent Loan Refinance and Sale. Explain each of these strategies and how they might be used.

This assignment is your study guide to ensure you have learned these materials before you take the required quiz.


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