A n oxymoron – a clever figure of speech that seemingly contradicts itself – can be pretty amusing. Jumbo shrimp. Postal Service. Justice Ginsburg. Devout atheist. Unbiased opinion.
One of our favorite finance-related oxymora is PERMANENT LOANS. Our partner Roger Williams leads an active practice group specializing in permanent loans for multifamily properties. But don’t be duped. Permanent loans are not permanent. In fact, many permanent loans have maturities of less than 10 years. Huh?
In the commercial finance ambit, time horizons are condensed. A bridge loan might last 1 – 2 years. A mini-perm loan might have a maturity of 5 years. Anything longer seems to, absurdly, qualify as permanent. As if to add mystery to the confusion, the term “permanent” in commercial finance parlance usually refers to a non-recourse loan at a fixed rate for 7 – 35 years with a 20 – 35 year amortization.
But let’s start at the beginning and assume the borrower is a real estate developer of market-rent multifamily properties. The typical, initial financing vehicle is a “mini-perm” construction loan from a traditional bank. A developer might obtain 85% loan-to-value financing with interest-only payments for two years followed by P&I payments for three years based on a 25-year amortization schedule. The developer will be required to guarantee the loan. After construction is complete, the developer will often look for a “permanent take-out” loan, seeking to (i) obtain long-term fixed-rate financing, (ii) shed liability from her financial statement, and (iii) “cash out” – that is, borrow more money than the payoff based on a new appraisal.
In the multifamily permanent finance market, there are myriad lender types and programs – including Fannie Mae, Freddie Mac, insurance companies, commercial mortgage-backed securities (CMBS), and HUD-insured loans. The typical Fannie Mae and Freddie Mac loans are non-recourse, fixed rate loans with 7 – 10 year terms, with interest only payments for the first 3 – 5 years. A HUD-insured loan might provide an appealing fixed rate with a bewildering 25 to 35-year maturity. The various permanent loan fixed rates are usually attractive — though likely above the mini-perm rate commonly tied to today’s pint-sized LIBOR index. Why wouldn’t a developer jump at this financing?
The phrase “nothing is easy” may have roots in permanent financing. Although the construction lender made the riskier loan based on ambitious plans for a piece of dirt, the faceless permanent lenders – fronted by loan brokers – step in only when everything is humming. They expect a neat package demonstrating a rent-stabilized project meeting high debt performance ratios, accompanied by final inspections, certificates of occupancy, an exception-free title policy, a no-qualifications as-built ALTA survey, certified rent rolls, multiple legal opinions, …. The process demands strict adherence to time-consuming, extensive qualification procedures that may even necessitate re-forming your entity in Delaware. The application includes prepayment of costs, an only-partially refundable fee, and – if you make to the commitment stage – a substantial rate lock deposit. The longer term HUD maturity comes with additional requisites beyond even the burdensom Freddie Mac and Fannie Mae requirements.
If the phrase “permanent loan” is an oxymoron, the term “non-recourse” is a borderline falsehood. What the brokers really mean is that the personal exposure of individual guarantors is significantly more limited than in a traditional guaranty. The wiliness is played by saying there is no personal liability except for the limited “bad boy carve-outs,” which, historically, included only truly egregious acts like fraud, waste, and environmental taint. The carve-outs, however, have sprouted to include what could be otherwise considered benign actions, and should now be more accurately termed “limited recourse.”
Even the phrase “rate lock” is abstruse. The permanent loan players have various programs with different “lock” mechanisms. In a typical Freddie Mac loan, the fixed rate is composed of two parts: the index (such as the 10-year Treasury) and a “spread.” As the index is mercurial, any quote is already history. Using examples from March 16, 2015 to April 21, 2015, the 10-year Treasury ranged from 1.85 to 2.10. The quoted spreads over the index on our recent transactions have ranged from 1.85 to 2.30. Freddie Mac provided an all-in quote of around 3.95% on a ten-year permanent loan in early April, but as the Treasury fell the spread seemed to grow such that the overall rate – remarkably – never fell below 3.95%. There are programs that allow a true rate lock at a specific rate with a window to close – but those require a signed agreement and hefty deposit.
Any minor movement in an all-in rate can be major. Shaving a mere 10 basis points (0.10%) on a $30,000,000 ten-year deal (assuming a 4% rate, interest-only for the first 3 years and an amortization of 25 years) results in a net present savings of about $190,000.
In addition to the issues listed above, permanent lenders limit prepayment. Some permanent loans include make-whole provisions or onerous defeasance requirements rather than the simpler prepayment penalty – but all include one of the three. Accordingly, with an early payoff, an amount that substantially exceeds the outstanding principal and accrued interest could be due.
For the sake of brevity, we have omitted discussions of non-housing permanent loans (shopping centers, office developments, nursing homes, etc.), low income housing, defeasance methodology, ADA compliance certificates, lockboxes, non-consolidation opinions, ALTA standards, and the significant nuances of closing.
In summary, a permanent loan offers a long-term fixed rate, reduced recourse, and a cash-out. Whether it is worth the endeavor depends on fluid, hard-to-quantify dynamics. Indeed, in today’s odd interest rate environment, after consideration of all the factors, a developer may find that the traditional bank lender offers a truly competitive product.
» Ben Williams and Molly Jeffcoat Moody are attorneys in a commercial law practice at Watkins & Eager PLLC (watkinseager.com). Ben is recognized by Chambers USA and Best Lawyers in America and was selected as Best Lawyer’s 2014 Commercial Finance Lawyer of the Year in Jackson. Molly is recognized by Chambers USA in the area of Real Estate Law.