Which Lenders Offer to Accept

Which Lender’s Offer To Accept?

by Jeff Wilder

Dated: 4.6.98

This past week-end I reviewed two written first mortgage offers, from well-regarded lenders, on a hotel that Wilder Group asset manages. Ironically, I decided to pursue the lender whose offer was $ 100,000 lower—and, at a slightly higher quoted rate of interest. Why?

In these days of abundant hotel loan capital, you often have choices of going with one of several lenders. Here are some things to keep in mind when making your financing choice.

1. Who’s more likely to close on the terms they initially offered?

Lender’s mortgage offers are always subject to "feeling the melon", otherwise known as underwriting and due diligence. This usually come in the form of required third party reports covering engineering, environmental matters, appraisal value, review of financial records, and the like. Naturally you want to make sure that, at the end of the process, you get the loan on the terms you were originally offered.

One mortgage offer we received (the higher one) required that the loan level be no greater than 70% of appraised value with a 1.6 debt service coverage ratio. The other offer (the lower one) had a loan cap equal to 75% of appraised value with a minimum debt service coverage ratio of 1.4. Therefore, the lower loan offer had appraisal and cash flow coverage rules that were easier targets to hit, resulting in a higher likelihood of closure at the originally offered loan level.

2. What’s the true interest rate being offered?

These days, most loans are originated by a lender and then re-sold in securitized packages. The debt market now seems to like 25 year mortgage schedules with 10 year terms. It evidently strikes a good balance for both borrower and lender. Usually the loans are priced at a spread above benchmark rates, i.e. the 10 year Treasury bond if it’s a 10 year loan. The spreads are now running between 170 and 185 basis points above the benchmark rate at the time of closing. However, the rate you’re getting may not be what you think you’ve bargained for. My friend Allen Shore, a very good business person, alerted me to this by sending me an article he’d read describing the fact that two lenders may offer you a seemingly similar rate, though one might be up to 20 basis points different than the quoted rate. This results from two factors:

a. a mortgage loan provider quoting on, say, a 10 year Treasury has the option of quoting the spread on-the-run (based on the current 10 year Treasury) or off-the-run (based on an older Treasury.) Generally, on-the-run Treasuries carry yields that are up to 5 basis points below off-the-run Treasuries of like maturity.

b. some mortgage loan providers calculate interest on a 30/360 day basis, while others use actual days/360. The actual/360 formula increases borrowing costs by 10 to 11 basis points, so less of your monthly payment goes to amortization.

Sure enough, after checking the two loans I was reviewing, one lender was using a formula that increased the real interest rate cost by 12 basis points over the quoted rate. And, that was the lender who offered us more money at an apparently lower rate. Thank you, Allen!

3. Negotiating Replacement Reserve clauses

As we all know, hotels are hungry devourers of capital. Most lenders have replacement reserve set-aside requirements, whereby you take a percentage of gross sales each month and put it in escrow for spending on the physical plant. But, when you need the money you don’t want to go through cartwheels to access it. This is especially important in the case of securitized loans where you don’t even know, at the closing, who will wind up owning your loan.

Do you have to pay the bill first and then request re-payment from the escrowed funds? Or, can you submit the bill for payment prior to making the expenditure? What is the practical recourse if you don’t receive your escrowed money in a timely manner? Are you earning interest on your funds, and at what rate? How expansive are the categories of items that your reserve funds may pay. These are all elements of the Replacement Reserve clause that require hard thinking and practical resolutions. One lender’s reserve clause policies may be different than another. Not getting the language and mechanisms of reimbursement smartly ironed out will assuredly cause chronic problems over the life of the loan that you simply don’t want.

In the case of the two loan proposals that I was reviewing, the mortgage loan provider offering $ 100,000 less happened to be much more liberal in what could be paid from the reserve for replacement account.

The three (3) areas I’ve addressed above were critical in my decision-making process. They were the main reasons that I decided to go with the lender who offered me

$ 100,000 less than was seemingly available from the second lender. Of course, other very important areas to look into are pre-payment provisions, guarantees, financial reporting requirements, and assumability, among others. Deciding on which loan to accept is a critical decision in the life of a real estate investment and can mean the gain or loss of hundreds of thousands of dollars of value if not analyzed very, very carefully.