Gap financing in today's conservative lending world8 Feb, 2013 By: Jeff Wilder Hotel and Motel Management
We’re in a period of time when low interest rates on relatively low loan-to-value debt is generally available to borrowers. While this financing is an excellent opportunity for those seeking loans at roundly 50 percent of property value, debt availability becomes more difficult to access as you climb the loan ladder to +/- 75 percent LTV.
There are junior funding options from existing secondary funding sources that are often available to finance a portion of the balance needed. Being alert to these opportunities may allow you to close on that low rate first mortgage and get the additional capital that may be necessary to close a deal. Let’s take a look at some of these options.
(1) Borrowing from a person that has cash available in his retirement account.
Hundreds of billions of dollars sit in individual personal retirement accounts, often of businesspeople you know, friends or relatives. The capital is usually invested in a range of stocks, bonds and money market accounts, often yielding 5 percent, or less, today. So, an investment paying more than that could be an attractive opportunity to the pension fund owner, and you often can create the investment vehicle to provide that option, such as those further discussed in (2) below.
It’s useful for you to know that retirement account owners are barred from investing in activities in which they have a personal interest; they can lend or invest money in your opportunity, but not borrow it for their own business or personal needs. Over the years, I’ve borrowed millions of dollars from friends and relatives’ retirement accounts and it’s always been a good deal for both sides.
(2) Offering junior debt or equity opportunities to private investors or banks.
In considering a potential new investment opportunity, while a first mortgage lender may offer you a 50 percent +/- LTV, and you may have, say, 25 percent of cash equity to invest, that still leaves a need for 25 percent more capital to fill the gap.
a. You could offer junior lenders, be they private or institutional, a secondary debt position at an interest rate higher than your first mortgage. If through a bank, the terms often require principal repayment within five years, which does put a lot of financial pressure on you, either through heavy principal payments on the debt, or a looming balloon payment that you may be unable to make at the end. However, if you are able to interest a lender in doing an interest only loan for a minimum of, say, five years, it may pay to take the risk.
b. Alternately, you could offer equity in the business to investors, thus eliminating the need for any fixed principal repayment or even an ongoing fixed guaranteed payment to the investor. Offering equity does bring with it the investment benefit of depreciation, which will shelter some, or all, of the early year yield on investment capital; this is very attractive to investors, especially in these times of higher income taxes. Of course, that does water down your equity ownership, which you may not wish to do.
c. Doing a Sale-leaseback of the land or building.
Hotels are businesses that exist in buildings built on land. That means there are three separate potential investment assets, and values can be created and assigned to each. You may want to keep full ownership of the hotel business through a lease contract and consider selling the building, land or both to investors.
These are just some ideas of ways to raise additional capital to cover the gap needed between the value of the hotel property and the very conservative, but low rate, LTV first mortgage financing available in today’s mortgage market.
Topic : Finance, Interest Rates, Loans
External Source : Hotel Management