Cheaper by the dozen: Multiple property financing

Real Estate Weekly, Sept 28, 2005 by Peter Berk

The timing couldn't be better: Interest rates are at historic lows, driving many owners to consider refinancing properties with debt currently coming due. But the best way to take advantage of the recent low interest rates, before those interest rates rocket up again over the next few years, may be to take a more long-term approach to debt. That means examining loans that are coming due in both the short and the medium term, and refinancing multiple properties, even if it means paying a prepayment penalty for the right to get out of existing debt.

And that's not a major sacrifice these days: the interest rate and terms available in today's market are often so much better then when the existing loan was made, that the "payback" period for the prepayment penalty is often less then two years.

For a borrower who can put multiple properties in a loan pool, the advantages he can expect from his lender are:

Superior Pricing: The pricing for loan portfolios is typically 10 to 15 basis points less then single assets. As a rule of thumb, the greater the diversity you are offering the lender (i.e. more diversified in terms of market and brand), the larger the discount in the spread. Borrowers often ask us to price loans as if they were done individually and also as a pool so that they can see the difference in pricing between the two.

The AFC Hotel Finance Group recently closed on a transaction where the individual pricing of the loans was 127 basis points over the 10-year treasury, and the portfolio pricing was 115 over--a significant interest savings for the borrower for doing a portfolio loan over the 10-year loan term.

Higher Loan Proceeds: Typically borrowers should expect 5% to 10% more in loan proceeds then if the properties were financed individually. Lenders routinely provide 75% financing on a first mortgage basis and will go up to 80% for certain well located assets.

Greater Document Flexibility: In loan documents there are many items that are negotiable. These include the percentage and timing of the FFE deposit, transfer provisions, structure of a cash management agreement and entity organizational structure. Lenders are more willing to offer more "borrower friendly" loan provisions for all these items in a portfolio transaction. The reasons are the same as before: you are offering the lender a safer loan in terms of diversification, and they are going to reward you with more generous loan terms for making their loan safer.

Lenders are in luck, too. From their perspective, a multiple property loan transaction or a portfolio loan is an ideal scenario; it's all about diversifying risk, and a portfolio loan helps them achieve that desired diversification on many different levels.

All the following reasons motivate a lender to become extremely aggressive when examining portfolio transactions:

Geographic and Market Diversity: Even if the property is located within the same general trade area, the fact that the properties serve slightly different segments within the trade area is advantageous. One segment of the market can suffer but things can be fine on the other (i.e. A plant can close on one end of town while the owner's other hotel located near a highway exit can be fine). Each hotel serves a different market within the same trade area.

Flag and Brand Diversity: Multiple property owners often have different brands of hotels and different flags within those brands. Each brand and flag caters to a slightly different market and those differences, although often subtle, create diversification for the lender.

Cross Collateralization: Although each hotel in a portfolio transaction is covered by an individual loan, related specifically to that hotel, all of the loans are tied together by a cross collateralization and cross default agreement. This agreement states that if one hotel were to default on an individual loan that it triggers a default on the entire portfolio. Although this sounds draconian, it is the lenders ultimate mechanism for achieving leverage over an owner in a failed property situation. It is also the lender's mechanism for allowing the cash flow from stronger assets to make up for the weaker ones.

Borrower Underwriting: At its heart, real estate lending for any type of property, is in large part, a lender taking a bet on the skill and dedication and attention to detail of the borrower/manager. This is especially true for hotels, where the daily management is often the key to success. Lenders who provide financing for hotels typically spend significant time with owners to understand their plan/vision for their company, examine their marketing plan, inspect the physical asset along with engineers, environmental consultants and appraisers and conduct a detailed review of the accounting records. This time-consuming process gets the lender comfortable with their new client.

With all of this upfront time necessary for a lender to get comfortable, it is less time consuming to do multiple transactions with that borrower, because each new transaction involves only a property underwriting, not a complete new borrower underwriting. This allows the lender to increase their loan production.