Maximum Leverage? Looking at Loan-to-Value Ratios by Property Type

Note: In this article, we hear from guest contributing blogger Kip Dunkelberger (kdunk@venturemortgage.com), the President and CEO of Venture Mortgage Corporation.  Kip leads this trusted, dynamic commercial real estate mortgage banking firm, and he himself is known as an experienced and resourceful problem solver in the realm of commercial real estate financing.  

Lenders evaluate commercial real estate largely based on the current and potential income generated by the property, the ease of finding replacement tenants (as applicable), and the degree to which the property is stabilized. With that in mind, let’s take a look at several property types and the general LTV ratios you can expect from potential lenders.

Remember that each piece of commercial real estate is a unique entity, and loan-to-value ratios can vary for a number of reasons: the examples below are presented in good faith only as general guidelines.

Multifamily

Multifamily properties have the distinct advantage of having tenants that are relatively easy to replace in the grand scheme of things. A single-tenant industrial building has a very limited, specific market of potential tenants, making it a riskier proposal in the eyes of a lender than a stabilized apartment building with thousands of potential tenants within a 5 mile radius on any given day. Therefore, owners of multifamily commercial real estate enjoy some of the highest LTV ratios in the market, and can push this ratio up to 85% in some cases, though 75 to 80% is more common.

Specialty/Recreational Properties

The income potential for these properties is largely seasonal and can be volatile, which can cause some lenders to be reluctant to lend on this type of commercial real estate at all. That is not to say all hope is lost: there are several lenders who are familiar and comfortable lending on these properties, and a commercial mortgage banker is a good option to assist borrowers in assessing the lay of the land in sourcing capital for these loans. However, because of the potential swings in income and the risk of drastic changes in the operating stability of these properties, borrowers should expect to see a cap of 50% LTV. Some very stable assets with a long history of good operation (and the documents to support such a history) could possibly push the LTV higher, perhaps to 55 or 60%, but that is relatively rare.

Borrowers should also be aware that valuation of these properties tends to be quite conservative, which could further reduce the potential loan size.

Retail (Strip/Center)

The retail sector of commercial real estate has seen some challenges in the past decade, but remains in relatively high esteem in the eyes of most lenders. It should be noted that retail centers are valued more highly (and have the corresponding higher LTV potential) if they contain one or more national, stable tenants (i.e., Walgreens, AutoZone, Caribou Coffee, Toys R Us, and the like) who will increase customer traffic for the lesser-known tenants and are unlikely to abruptly vacate or go out of business. Lenders also like to see leases with many years remaining for each tenant at the time of origination, which assures them that a property that is currently operating well will not lose half its tenants shortly after closing, and the higher the occupancy rate, the better. A stable retail strip center with low vacancy and good tenants can expect about a 70% LTV ratio, with very well-performing properties able to reach closer to 75% LTV.

Triple Net Leased National Single Tenant Retail

Perhaps the holy grail of leases, the true NNN or triple net lease obligates the tenant to be responsible for taxes, insurance, maintenance, capital expenses, and any other operating expenses associated with a subject property. The owner, in essence, only collects rent and pays the debt service to the lender. When combined with a long lease and a national, publicly traded company as the tenant (Wal-Mart, Best Buy, Aldi, Nordstrom, etc.), lenders are quite comfortable with LTVs up to 85% for these properties; in some cases, special loan programs offer the opportunity for a 90% LTV if the tenant has an especially good credit rating.

Here, we’ve looked a just a few of the many property types in commercial real estate and the range of loan-to-value ratios for each. We’ve explored the reasoning behind the LTV spectrum from the lender’s perspective, and we’ve advised that seeking a consultation with an experienced commercial mortgage banker can provide you with advice regarding the best lender for your property type, situation, and objectives. When it comes to commercial real estate financing, remember that tenants and cash flow are keys to a stabilized, well-performing property that makes lenders comfortable with a potential investment and allow borrowers to maximize their leverage. 

If you have questions about obtaining a mortgage or financing for a reverse exchange or any other commercial real estate investment, you are invited to call Kip Dunkelberger at (952) 843-5125, or email him at kdunk@venturemortgage.com.

Find Venture Mortgage online:

www.venturemortgage.com

Whiteboard Video - Title Closers & Closing Costs in a 1031 Exchange

In this whiteboard animation video, we discuss the various expenses that title closers need to be aware of in a 1031 exchange.

• Start Your 1031 Exchange: If you have questions about 1031 closing expenses, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Can I Modify my Identified Property after Day 45?

Sometimes people want to know if their replacement property identification can be modified after the 45th day but before they received the replacement property.

Changing Your Identification

The answer to the question is if you want to change your ID after midnight of the 45th day you are SOL that is Statutorily Out of Luck because the code and the regulations don't permit you to change your identification after the 45th day. However, before the 45th day if you want to remove your identification, or amended, or completely replace it you can do that right up until midnight of the 45th day by sending a new identification or a new written revocation that's signed by the taxpayer and sent by midnight of the 45th day.

• Start Your 1031 Exchange: If you have questions about 1031 timelines, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Giving Written Notice in Your Purchase Agreement

In a 1031 exchange, typically the purchase agreements for the sale of the relinquished property or the purchase of the new replacement property are assigned to the intermediary by the taxpayer that's doing the exchange.

Old English Common Law

Under the Old English common law, an assignment was not considered effective until all of the parties to the contract were given written notice of the assignment. The IRS has adopted this Old English concept and in the context of a 1031 exchange when the seller of a relinquished property assigns their rights in the relinquished property purchase agreement to their intermediary, that necessitates the seller giving notice to the buyer of the relinquished property as well as any assignee, or parties that were assigned rights in that contract.

Well sometimes that's easy to do and sometimes it's hard to do because the buyer that's actually purchasing the property may or may not be affiliated with the original contracting party and it's sometimes difficult to track down all of the parties to the contract and give them written notice.

Replacement Property

The same thing goes on the replacement property. When you contract with the seller of the replacement property and then assign your rights in that purchase agreement to the intermediary, you must give written notice to that seller. There is often less rigmarole and assignments of the replacement property purchase agreement but nevertheless, if there are any other parties in that purchase agreement the treasury regulations require that the taxpayer give those other parties written notice of the assignment to the intermediary.

Making it Happen

So how do you make sure that you get that written notice proved up? You ask those other parties to sign an acknowledgement that they received written notice. How do you make sure that these other parties do that and give you the written proof? You make it a contractual requirement in your purchase agreements that ALL of the other parties will cooperate and will provide you with that requisite acknowledgment at or prior to closing.

For a sample 1031 cooperation clause, check out this link.

• Start Your 1031 Exchange: If you have questions about 1031 purchase agreements and cooperation clauses, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved

Rental Property 1031 Exchange Rules

A client recently came to us with the following 1031 situation:

We have named a property in Edina, which is priced at $450k. We plan to rent it out at the beginning, and move in later. Our question is, how long do we have to rent out the house before we can move in and convert it to our primary residence, without the profit gain penalty?

No Clear Answer

That is a very good question, for which there is not a clear answer.

We know from the Internal Revenue Code that your initial intention (mental state) must be to hold the Replacement Property for productive use in a trade or business or for investment. It is okay to have an “indeterminate” long term intention as to what you may do with it much later. However, I would not say with 100% certainty that you will be able to move in to it as your home at this time.

The Code

26 U.S. Code § 1031 - Exchange of property held for productive use or investment

(a)  Nonrecognition of gain or loss from exchanges solely in kind 

(1)  In general

No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.

Holding Periods

There is not a bright line minimum time period that I can point you to. The safe answer is “The longer…the better.”  Two years of holding it for investment / business purposes may be sufficient for most taxpayers. Check with your CPA or tax adviser about your specific situation.

• Start Your 1031 Exchange: If you have questions about 1031 rental properties and holding periods, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved