Musings on commercial
real estate finance
What is the SBA Paycheck Protection Program and how can you apply?
April 5th, 2020
As of April 3rd, the U.S. Small Business Administration (SBA) has made $349Bn available under the CARES act "Paycheck Protection Program" to help businesses keep employees on payroll.
Even further, if at least 75% of those loan proceeds are used directly for payroll, the SBA will forgive the loan entirely after 8 weeks. It effectively becomes a grant.
The issue so far has been that the banks are moving at a glacial pace. The loans carry just a 1% interest rate. And though they can be compared to the 2 month treasury (0.11% as of 4/3), they are trying to figure out how to turn this relief fund into a land grab. Many are only granting the relief if you are a preferred client of the bank, or if you are willing to switch over.
That is just not good enough. So TapCap is partnering with alternative SBA lenders who can deliver efficiently, with zero hidden fees and zero strings attached.
Who is the program for?
While typical SBA loans exclude nonprofits, the paycheck protection program includes all nonprofit 501(c)(3), veterans organizations 501(c)(19), tribal business concerns 31(b)(2)(c).
Individual contractors and other self-employed individuals are eligible too.
The only companies not eligible are companies owned by individuals who are incarcerated, on probation, convicted of a felony in the last 5 years or who have previously been delinquent or defaulted on a loan from the SBA .
The lesser of:
* The maximum monthly paycheck size allowed is $8,333 (eq. $100,000 annual)
The loan carries a 1% annual interest rate. There are no payments for the first 6 months - interest accrues for the first 6 months and is paid equally through the duration of the loan.
All Interest and principle can be 100% forgiven by the SBA if at least 75% of loan proceeds are used for payroll
At least 75% of the proceeds must be used to cover payroll, including salary, health insurance, wages, commissions, cash tips; parental, family, and medical leave.
The other 25% may be used for mortgage, rent and utility payments.
How do I apply?
TapCap is partnering with a select few SBA lenders who pledge to be honest and transparent through the process, and to lend with zero strings attached.
We are developing an app that will guide you step by step through the process. We expect the first version of the app to release by April 17th.
Please note that this is a moving target. Any TapCap service or statement is not a guarantee of loan approval. Eligibility and terms are ultimately decided by the SBA and the licensed SBA lender. This site does not constitute an offer to lend or provide a service by TapCap Co. or any other third party regardless of whether product or service is referenced herein. Furthermore, nothing here is intended to provide tax, legal, or financial advice and nothing in this website should be construed as a recommendation to engage in any transaction.
Oh, and if you would like to help, please send us an email at firstname.lastname@example.org.
Stay Safe, Stay Healthy, We are all in this together.
Funds to be distributed to Small Businesses to help cover payroll.
**The program is intended for all U.S. based businesses with 500 employees or fewer.**
How much can my business qualify for?
2.5 x average monthly payroll expense*
Acme Corp has 5 employees. As of February 15th, 2020, the payroll schedule for the company was:
2.5 x $35,000 = $87,500
Acme Corp would qualify for an $87,500 loan.
What are the terms of the loan?
The loan has a 2 year term - however the full principle and accrued interest can be forgiven by the SBA after 8 weeks.
This loan is non-recourse. The full principle and interest can be forgiven as long as the above term is followed (75% payroll).
If the funds are used for unauthorized purposes, the SBA will direct you to repay those amounts. If you knowingly use the funds for unauthorized purposes, you will be subject to additional liability such as charges for fraud. If one of your shareholders, members, or partners uses PPP funds for unauthorized purposes, the SBA will have recourse against the shareholder, member, or partner for the unauthorized use.
**UPDATE: As of 4/13, The SBA has approved several large Fintech groups, such as Paypal, to offer
SBA PPP loans directly. We believe that these groups will address the need far better than the
incumbent banks. With their entrance, we believe the need for us to develop an app has ceased.
TapCap will no longer be developing a PPP app and will continue to focus on multifamily.
You must demonstrate that the property has come under financial hardship due to the crisis and that the property will not be able to make its current loan payment. A clear indicator is if your Debt Service Coverage (Property NOI / Loan P&I Payment) has reduced to under 1.0 in March or the coming months.
Obtaining financial relief for your multifamily property during the COVID pandemic.
March 26th, 2020
Barely a month ago loans were cheap, real estate transactions were booming - we all were shaking those hands and making those deals (some without hand sanitizer even).
I imagine you, like me, might be sitting at a "home office" - perhaps even with some "home staff". I for one have been demoted from manager to janitor at this office - I'm sure you've had to make some adjustments too.
On to adjustments, I would like to share what we've been seeing in the multifamily space as a result of the COVID-19 pandemic. This article will specifically address the Fannie and Freddie mortgage relief/forbearance program.
The below outlines programs for properties with mortgages that are federally insured, guaranteed, supplemented or assisted mortgages, including mortgages purchased or securitized by the GSEs. The below programs are still actively being determined and are subject to change. The information below is not guaranteed to be up to date or accurate For all immediate inquiries and for other loan types, call us and your current loan asset manager.
Fannie and Freddie (and in a delayed fashion, GNMA) are pushing forward relief efforts to help what may be over 50,000 properties in need of some level of relief. The primary form of relief is in mortgage forbearance.
Mortgage Forbearance /fawr-bair-uhns/ : An agreement in which the lender agrees not to foreclose on a mortgage and the borrower agrees to a mortgage plan that will bring the mortgage current over a certain time period.
In this case, If the property owner agrees not to evict any tenants due to financial hardship caused by the pandemic, COVID-19, the agencies will allow the borrowers to defer their full P&I loan payments for up to 90 days.
You qualify if:
Your property collected $200,000 after expenses for each month of December, January and February. Your monthly loan payment is $160,000. Your debt service coverage is 200,000 / 160,000 = 1.25
In March, your collections dropped and your property income after expenses is now $150,000. Your debt service coverage is now .94.
Prior to 3/31
Your loan prior to March was current. All debt, tax and insurance payments on your property were current as of March, 2020. Loans that were already delinquent may not be eligible for mortgage forbearance.
How to Apply:
Note that you can only apply for forbearance after you can demonstrate a debt service coverage of under 1.0.
Collect recent rent rolls, and put together a month to month income statement showing incomes and expenses for at least the months dating back to December 2019.
Ensure that you can illustrate a debt service coverage (income after expenses divided by loan payment amount) of over 1.0 before March and under 1.0 after March.
Get in contact with your lender/servicer's asset manager. Make the following statement:
"As a result of the ongoing health crisis created by the COVID-19 virus, we are experiencing lower rental collections at our property located at <insert street address>. Prior to this crisis, the operations were current on all debt, tax and insurance payments. In order to remain fully operational, we would like to request financial relief and mortgage forbearance."
The servicer will send a short legal letter dictating the terms of the forbearance. Review this letter with your legal counsel. If the terms are agreeable, execute and send back to the servicer. Formal agreement of the forbearance will be issued in writing and should take no longer than 48 hours to process. Below are some common terms to look out for.
Terms of the Forbearance:
The duration of the agency relief program is typically 90 days (30 days with 2 extensions). If you apply and are granted forbearance in June, your July, August and September payments will be deferred. The agencies can approve longer durations, but this is on a case-by-case basis.
The deferred payments will be paid back in 12 equal, monthly installments without interest or fee after the forbearance term ends.
When reviewing the forbearance agreement from the servicer, ensure that there will be zero additional late fees and default/deferred interest due on the deferred loan payments.
No tenants may be evicted from the property due to financial hardship for at least 3 months and until the property has paid back the full amount of deferred loan payments.
No cash distributions to any equity holders until the property has paid back the full amount of deferred loan payments.
Taxes and Insurance may be able to be advanced by the loan servicer.
Currently, the last date to apply for mortgage forbearance is August 31st.
Extra Relief Programs
There is talk of allowing properties to pull from their repair and maintenance reserves to fund short term cash shortfalls resulting from the COVID-19 virus. While the mortgage forbearance program is the primary way to seek relief, in the event additional relief is required, your loan servicer may be able to approve the use of cash reserved for repairs and maintenance to cover short term operational deficit.
This has certainly been a shock. While the U.S. president and his administration are trying to get us out of quarantine and back in the office, we have to be prepared for this to last another 60-120 days. The good news is, America holds housing sacred - it’s part of the dream - and the government has made demonstrations that it is ready to support our industry. We at TapCap are in touch with owners, investors, banks, lenders and servicers - if any of this can be helpful to you, please reach out.
Stay safe, stay healthy, and please know, we are here and ready to help.
Much can happen in 10 years. Loan rates will fluctuate, cap rates will eventually move (though they've been largely stubborn this last decade), and the property's market may boom or bust.
This analysis is largely oversimplified since it keeps those variables constant. Still, by doing so we are able to tease out the differences between these two penalties.
Yield maintenance, with its reduced rate, looks a lot nicer on a term sheet. There are significant cumulative savings that rack up as well, and an early prepay may not be as prohibitive as typically assumed.
Alternatively, declining prepay has an obvious advantage - it grants flexibility, which will work to your benefit if markets move favorably, or even if they remain the same. That flexibility certainly comes at a price, but the ability to realize capital appreciation several years earlier, or even the flexibility to sell the property may very well be worth that price.
TapCap can help you review the long-term financial impact different prepayment options will have.
Bottom line: There are typically several prepayment options available to you. Compare each one from the perspective of the exit, not the entry.
To zoom in on figures from the graph in Figure 3,
The graph shows us that yield maintenance is significantly higher than declining prepay until slightly after 2019 (and often, YM clauses include a greater of YM or 1% - this is why).
Savings from choosing YM
The above analysis is missing a key component, however. The type of prepay you select has a direct effect on the interest rate you pay. Since the bond investor's yield is better protected under yield maintenance than declining prepay, the rate demanded will be less.
Though the precise difference between the two depends on a number of factors, primary is the duration of the prepayment term.
To graph the complete scenario, we should include the cumulative debt service savings you receive by selecting yield maintenance. We've assumed a 0.45% difference in APR, which is approximately the spread today.
Figure 4: Graph of Cumulative Savings
Yield Maintenance vs Declining Prepay: The price of locking in.
December 17th, 2019
In roughly 4 out of 5 multifamily agency loans originated over the last decade, borrowers chose a yield maintenance type of prepayment scheme over declining prepay.
Was it a wise choice to lock-in or was is it shortsighted?
Comparing the two prepayment types over a 10-year loan term
For our use, we'll look at two identical loans, one with 9.5 years of yield maintenance (YM) and another with a standard declining prepay (DPP).
*There is a rate difference between the two types of prepay - the reason for which we will discuss in the next section.
Figure 1: Graph of Declining Prepay
A common declining prepay penalty schedule is 5%, 5%, 4%, 4%, 3%, 3%, 2%, 2%, 1%, 1%. Each percentage number represents a fixed fee amount a borrower must pay in order to prepay early. The order corresponds to the year in which the prepay occurs. For example, prepaying in the third year corresponds to a 4% penalty whereas paying off in the 7th year corresponds to a 2% penalty.
In Figure 1, our prepay "steps down" every 2 years as expected. The slight downward angle in between years is explained by the amortizing principle balance.
Yield maintenance is a different sort of prepayment penalty that essentially seeks to mitigate the bond investor's loss upon loan prepayment. In lieu of the anticipated interest income the bond investor was to receive from the loan, the bond investor is paid the present value of the ongoing spread between your loan's interest rate and the benchmark, risk-free rate (in this example, the corresponding treasury).
Figure 2: Graph of Yield Maintenance
In Figure 2, we've modeled 9.5 years of yield maintenance, which is common for a 10 year loan. The fluctuations here are due to the ongoing movements of the underlying treasury rate (and the enormous treasury moves toward the beginning of this past decade).
While the specific yield maintenance calculation can be found in this article, it is suffice to keep in mind that the lower the treasury, the greater the spread between it and the loan rate and therefore the greater the yield maintenance amount.
Side by side
Placing the two types side by side, it would appear obvious that the yield maintenance provision essentially locks you in for a majority of the duration of the loan, given its prohibitively large prepayment amount.
Figure 3: Graph of Yield Maintenance Versus Declining Prepay
The Refinance Scenario
In our analysis thus far, it still appears that prepayment with YM before 2018 is largely prohibitive, even when accounting for cumulative savings.
However, there is yet another item that we must take into account - the amortization of the loan and the absorption of the prepayment by the new loan.
After 7 years of principle payments, our unpaid principle balance (UPB) has amortized.
Furthermore, the property's income & expenses have likely grown, which result in a larger loan available.
*This assumes an equivalent cap rate and that income and expenses grew at a similar rate, compounded annually. Increased loan amount based simply on increased cashflow - other factors were not considered.
While the prepayment penalty may be steep, there is often sufficient room between a new loan amount and the current UPB.
*This amount includes the cumulative debt service savings for YM.
Growth New Loan*
Another way of looking at this is to subtract the cumulative savings from the yield maintenance prepayment amount:
Figure 5: Graph of Effective Yield Maintenance
Looking at the difference from this angle in Figure 5, the effective yield maintenance matches declining prepay just before 2018.
To put figures to this graph:
YM Debt Savings Effective YM DPP
You've likely seen news articles recently about the U.S. Fed reducing interest rates and how this will lower mortgage rates across the board. You may be asking yourself how this might impact you.
Perhaps you're the type that always has CNBC playing in the background or maybe you simply look at mortgage rates when you need to (or when those ads pop up "mortgage bankers hate this guy for revealing this secret!"). In either case, not many investors, whether in the commercial real estate industry or outside, know all the ingredients that get stacked into their multifamily mortgage.
So let's break them out. For reference, we will look at a typical 10 year loan from either of the agencies, Fannie Mae or Freddie Mac. FHA, CMBS and other debt sources stack up a bit differently. However, considering that nearly half of multifamily transactions happen through one of the agencies, it's a good place to start.
Infographic: What goes into an agency rate?
August 20, 2019
At the base of our (fixed) rate is the U.S. treasury (floating rates use LIBOR as the benchmark instead). Since our example references a 10-year loan, the 10-year Treasury Note is used as the benchmark.
This rate fluctuates daily and impacts the entire industry.
Agency Guarantee Fee
This is the fee that the agencies receive in return for guaranteeing the loan. The role of a debt guarantor is outside the scope of this article, however investopedia has a good summary of the history and economic importance of this role. The agencies are able to compete with one another by adjusting their guaranty fee. They might also introduce special programs where they reduce their fee in order to incentivize real estate investors to either provide affordable units or become more energy efficient.
Investor Credit Spread
After your loan is originated, typically the agencies will purchase the loan from the lender and securitize it for sale in the secondary market. While agency guaranteed mortgage backed securities are considered very safe investments, they do have more risk than, say, a U.S. treasury note. How much more risk depends on investor outlook of the U.S. commercial real estate industry and is reflected in this spread.
Again, investopedia has a nice article summarizing credit spread, with a video tutorial to go along with it.
The treasury + the investor spread is also known as the pass-through rate, as that is the rate that is “passed through” to the bond investor. Using the infographic above, the pass-through rate here is 1.60% + 0.56% = 2.16%.
After your loan is funded, a loan servicer is appointed to collect your mortgage payments. The servicer serves several key functions, including ensuring that your property operations are compliant with the loan requirements and reporting asset performance to the bond investors.
For this service, the loan servicer collects an ongoing fee that is built into your interest rate. With agency loans, the lender typically remains as the servicer. The lender is able to adjust how much of a servicing fee they would like to include (subject to agency-set minimums).
Yield Spread Premium
All of the previous sections sum up to what is called par pricing. In the infographic above, par is 3.7%. At par, the lender does not receive any premium on the sale of the note.
Interest rates above par pricing will net the lender a cash premium. How much of a premium the lender receives is subject to the secondary market, but the mechanics are explained well in this article (specifically, the section on yield-to-maturity).
To use an example, let's assume that bond investors are willing to pay 1% more for every 0.15% increase in interest rate. In the above infographic, there is 0.30% built into the rate, which means a bond investor would pay 2% more for this loan. If the loan amount was $10M, bond investors would buy the note for $10,200,000 which means the loan originator would gain $200,000 in premium.
This is how agency lenders compete with one another. Typically a lender will quote a combination of upfront origination fee (sometimes referred to as the financing/placement fee) combined with some amount of yield spread premium built in. This total profitability can be shared with the mortgage broker as well (both the fee and the premium).
It should be noted that the agencies require that lenders charge some sort of minimum fee (via upfront fee & yield spread) for their service so that no lender can totally bottom-out the market.
While yield spread can be used as a way for brokers to make additional commission without borrowers knowing (the amount of yield spread built in is rarely communicated), it can also be used as a good tool for real estate investors looking to minimize upfront fees. Lenders are often able to move many of the upfront financing fees into the yield spread, which means your out-of-pocket can be significantly reduced (in return for accepting a higher rate).
So why is the rate on my loan quote different?
When you receive loan quotes from different lenders, there are several factors that could make one quoted rate higher than the next:
1. Assumptions on agency exceptions/reductions. Lenders may assume upfront that they will achieve certain interest rate reductions from the agencies based on their evaluation of your property. All lenders can apply for these exceptions, but some lenders will prefer to quote conservatively (not assume waivers) and over-deliver if they achieve an interest rate reduction.
2. Servicing fee. Lenders have the ability to reduce the servicing fee, subject to a minimum amount set by the agencies.
3. Yield spread. This is the most likely reason for differences in rate. In combination with financing fees, this is how much the lender will make on the loan. Since the revenue from upfront fees and yield spread both go to the lender, borrowers can request whether they want to pay more upfront and less in rate or vice versa.
It should be re-emphasized that the actual percentage breakdown is constantly shifting and that the above allocations are simply approximates.
At TapCap, our goal is to make the multifamily mortgage process simple, convenient & transparent for you. It is common for loan originators to try to keep certain items, such as yield spread and price waivers opaque. We put an absolute halt on this practice and instead remain completely transparent with you about your loan.
You can use the TapCap loan app to review accurate loan pricing, updated daily.
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