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Financing advice for new office

quadrupledeac

quadrupledeac

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I need help choosing the best way to finance our group's new office building.

Loan amount is $1, 275, 000.

Option one is 10 year LIBOR + 2.5% with minimum of 3.25% until rate swap is executed.

Option two is 10 year fixed at 4.5%.

My partners who are more seasoned (read old) prefer option one. I, the relative ignoramus on matters of finance, prefer the conservative nature of a fixed rate loan. I also have heard reports of the impending crisis with so called zombie loans in the commercial real estate world and wonder what effect that will have on adjustable rate mortgages going forward.

Would appreciate any thoughtful advice from those in the know as well as a "interest rate swaps for dummies" cliff notes version.

PS- The reason I am not just calling our banker about this is because I think he is a jackass and I have more faith in the Deacon bankers of the pit.
 
Everyone I know who has done swaps in the small amounts you are talking about (relatively speaking, of course) ends up getting bent over on the bank fees, making it pretty much useless and a giant waste of resources.
 
I'm the controller of a real estate company and deal with these sort of things all the time.

The part I'm confused about is "until the swap rate is executed" Normally what you do is enter into the swap at the time you start the loan, and you swap into a fixed rate, and you simply need to get in touch with a derivatives person (usually the lender has their own group do it) and they will tell you what your fixed rate is, and you compare it to the 4.5% and if its less you do the adjustable rate mortgage but enter into a swap to fix your costs.
 
The rates we are getting nowadays are no where near 4.5% (We just did one at 5.05% this week on a refinance), so on the face 4.5% doesn't sound bad, but it shouldn't cost you anything to find the price on doing option #1 but swapping into a fixed.
 
Without knowing the particulars of your request, 10 years fixed at 4.5% is pretty strong. I would be very, very careful with swaps. If you ever touch the note (pay off early, refi w/ cash out, modify signers/guarantors, etc.) before maturity and the swap is out of the money....you my friend will be owing a very hefty fee.
 
is this 10 years with 10 years of amortization or is it 10 year with 30 years of amortization?
 
the one year libor rate has averaged 2.6% over the last ten years (which included the last 2 years which have been unprecedented and potentially fraudulent). This plus 2.5% is 5.1%. I doubt rates will stay as low as they have been for more than the next 3-4 years max so I would probably go withthe 4.5% fixed.
 
Our oldest partner who has equity in our current building needs to be sole guarantor for the new building for a period of time (1 year) in order that he can parlay his share of the sale of our current building into a down payment on the new building without paying taxes on it. The other two partners will be joining him as guarantors (joining the LLC) after the year or so passes. Are you saying that simply by adding the two remaining partners as guarantors in a year, that the bank can impose high fees, and if so is this unique to the LIBOR ARM versus the fixed rate loan? Our banker has intimated that the fees associated with adding two new guarantors by way of them joining the LLC will be nominal (a few thousand dollars).
 
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quadrupledeac said:
Our oldest partner who has equity in our current building needs to be sole guarantor for the new building for a period of time (1 year) in order that he can parlay his share of the sale of our current building into a down payment on the new building without paying taxes on it. The other two partners will be joining him as guarantors (joining the LLC) after the year or so passes. Are you saying that simply by adding the two remaining partners as guarantors in a year, that the bank can impose high fees, and if so is this unique to the LIBOR ARM versus the fixed rate loan? Our banker has intimated that the fees associated with adding two new guarantors by way of them joining the LLC will be nominal (a few thousand dollars).
Click to expand...

adding guarantors but not changing the payment structure shouldn't really carry any fees.

i would probably go with the fixed rate over the synthetic. given the fact that you are in some sort of professional practice, chances are there is going to be some movement in the next 10 years that may result in buying someone out or adding someone and resetting the loan. you can do this (assuming your bank doesn't put any prepayment fees on the note) but then your hedge will be mismatched and it could turn into a nightmare. getting out of the swap could cost you big time if you are out of the money.
 
Yeah I generally agree. Hedges can make things really tricky and not flexible. Since you're already paying 4.5% which is low, I would just stick with the fixed over paying potentially slightly less interest by swapping. Even if you're say at 4% by doing the swap, we're only talking about $6,000/year in savings.
 
Adding guarantors can be as easy as a one page Change in Terms Agreement (which would not affect the swap) , or your lender may require full blown underwriting and a new set of loan documents if there are any fundamental changes in the ownership structure of the borrowing entity. In this lending envirnoment I would not make any assumptions with a lender's credit policy and what makes practical sense. If the option is out of the money, and the borrower unwinds, that break fee could cost tens of thousands.

As stated above, go with the fixed rate.
 
Thanks to everyone for the advice. I was sketchy on the swap option before starting this thread and am even moreso now. One more question. The fixed rate option has a 1% prepayment penalty during the term of the loan. Does this mean we cannot pay down any principle earlier in the loan? Sorry but the more I get into these issues the more I realize how clueless I am.
 
most banks will have some amount that you can prepay without triggering the penalty. i'd guess it is something like 10% of the balance in a payment cycle. you should be able to get some clarification from the banker on that.
 
quadrupledeac said:
Thanks to everyone for the advice. I was sketchy on the swap option before starting this thread and am even moreso now. One more question. The fixed rate option has a 1% prepayment penalty during the term of the loan. Does this mean we cannot pay down any principle earlier in the loan? Sorry but the more I get into these issues the more I realize how clueless I am.
Click to expand...

You can't pay down any additional unscheduled principal without paying the 1%, which is fairly standard for these types of deals, although can be negotiable depending on the bank. 1% is a fairly low pre-pay.
 
maybe that's how yall do it on the left coast, but everything i've seen allows for some prepayment (again, maybe 10% of the balance) without tripping the penalty.
 
quadrupledeac said:
Thanks to everyone for the advice. I was sketchy on the swap option before starting this thread and am even moreso now. One more question. The fixed rate option has a 1% prepayment penalty during the term of the loan. Does this mean we cannot pay down any principle earlier in the loan? Sorry but the more I get into these issues the more I realize how clueless I am.
Click to expand...

on big loans like this, the bank really wants to get the interest so this is basically call protection against you paying them off and getting a cheaper mortgage somewhere else.

i can't see much reason for you guys to pay down additional principal at these rates so it should be a moot point
 
bmoneydeac said:
maybe that's how yall do it on the left coast, but everything i've seen allows for some prepayment (again, maybe 10% of the balance) without tripping the penalty.
Click to expand...

I've seen it that way but most of our commercial deals are a graduated scale, locked out or high prepay, eventually going down to 1 or 0% closer to maturity.
 
Every prepayment penalty that we've put on commercial paper (typical 3/2/1%) relates to outside refinances by another lender....not if you prepay with internally generated funds. Ask for clarification.
 
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