Capital Stack Series: Financing

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Welcome back everyone to the Capital Stack miniseries. I'm your host James Nelson, principal and head of Tri State Investment Sales at Avison Young. I'm here with Scott Singer, our co head of the debt and equity group. Scott, thanks again for joining us and doing this.

Dave, glad to be here.

Wonderful. We've already had two really great sessions where we talked first of all about the role of the debt equity advisor, the right time to connect, how can a sponsor borrower put themselves in the best position for success and you know, how does someone get started? So that was the intro, so we'll put that in the show notes as well as it would be helpful if you listen to these sequentially. The next thing we talked about was key terms and sizings. We talked about the components of the capital stack. We talked about the difference between common and preferred equity. We talked about the difference between senior mezzanine debt. We talked about intercreditor agreements and how the priority works. We talked about loan to value, what's left? Well now we're talking about financing. Now we got to actually talk about. Now we've kind of defined the key terms. Now we've got to talk about what type of lenders are out there, what type of debt is available. So Scott, what are the different types of lenders? When, when you've been retained to go out and provide financing, what are the different buckets of capital that you're out there looking for on the debt side?

Sure. So we differentiate between banks, let's say most generically banks, both foreign and domestic institutions, which generally refers to insurance companies and pension funds, CMBS lenders and funds of other types, investment funds which are sometimes referred to as non bank sources. Those are the basic categories of debt providers. It expands and so developers have become debt providers and others. But that's the basic breakdown.

Okay. And I think what might, I want to say create confusion but sometimes if you're dealing with a bank there can be different types of, you know, the different types of financing available. So you know, some of these big national banks, they lend on their balance sheet but they also could be doing cmbs. So with under an umbrella that they could have multiple types of financing. Correct?

That's true. When I started in the early 90s it was a much simpler division. There were savings banks who made fixed rate loans. There were commercial banks who made construction loans that were floating. There were no. Well there were. But investment banks were not making real estate loans. And if you wanted a long term fixed rate financing, it was an insurance company. I Assume an insurance company or a pension fund. And that all started to change first with the advent of CMBS financing and the current incarnation which started in the early 90s. And that brought investment banks into real estate, it brought commercial banks into the Wall street cmbs. And then there have been further changes from there.

Okay, so, and I don't know, there's also, when you look at multifamily debt, you also have agency. So I don't know what you would put that into, but maybe that's worth covering as well.

No, it's a good point. And that, that it is a somewhat separate class of financing long term for multifamily only assets. So that's Freddie Mac and Fannie Mae. And then an additional source would be HUD or H or FHA financing. So they're really, it's a pretty, it's a pretty varied group and there is, there's differentiation in different ways. So I said before, insurance companies used to make only long term, fixed rate, super safe loans. That was at a time when they were lending only their own balance sheet money or money coming from the premiums or general account, it's really called in an insurance company. Over time, insurance companies became investment managers. And once they were investment managers, in addition to lending their general account money, for which they generally want very safe long investments, they also started taking money from other sources who were looking to them for different things, including more yield. So we're in an environment now where it's probably the most robust supply of capital that I've seen at any point in my career, despite the headlines, despite the challenges with some asset classes.

So I just want to go back to the agency just to kind of define so that these are governmental agencies. Right. With Fannie and Freddie to talk about, is it actually the federal government lending the money or just. So tell our audience exactly how that works.

So yes, but or no maybe it is very complicated. And Fannie and Freddie were originally it was government sponsored programs to stimulate the development and improvement of housing and primarily affordable housing with a small A. And it's morphed over time. It's a little hard to fully determine what they are at this point. They are public companies. Their stock and preferred stock is in play. There was just an article about that they have an implied guarantee. There is an expectation in the loans that they make that should there be a problem that the government will step in and protect the owners of the debt, meaning the bondholders who are essentially the lenders. So it's really hard to summarize quickly but the effect of the implied government guarantee has been that Fannie and Frederie have generally over the last 30 years, been very liquid providers of very attractive financing for multifamily.

Perfect. Okay, so I want to eventually get to the advantages or disadvantages considerations of these various debt providers. But before we do that, when you get a mandate, how do you decide which of these types of lenders that you're going to pursue? Or in many cases, you might be pursuing different channels to get different options on the table? So is it just kind of your knowledge and experience over decades to figure out what's the, you know, the capital source that's going to be? Right. I would imagine that things also change, right. As far as who has liquidity and where you can place a loan.

Things absolutely change. And it is at the root a combination of our experience, knowledge, expertise, as well as our constant outreach to be keeping track of what both the old and the new sources are doing. It is, and it's evolved over time, for sure. It used to be the case that there was a smaller number of lenders. They were very fixed in what they did. When we took on a new assignment, there was a fairly short list that we were quite certain would be the most, the only ones who are going to be the most competitive. That's really changed over time. We've had two stretches in the last, let's say last seven or eight years where we did 25 loans in a row with different lenders, and that included repeat business, same clients, similar deals, sometimes a virtually identical deal one after another where one lender had differentiated on the first process, and then in something that happened a few weeks later, a different one stepped up. So in some regards, it's part of what's fun and exciting about the business that we don't know going in, who's going to win now? And I say that in a positive way. It's because there's so much competition for deals that are structured correctly for the market environment.

So, Scott, I got to add another question at this time because I know a lot of borrowers out there, and especially if you're on your fifth, 10th, 20th deal, would speak to the benefits of a relationship lender. Where you've gone, you've done repeat business, they've already qualified, you know, the process, obviously, that, that track record. So. But I'm now hearing, you know, 25 deals, 25 different lenders, even with the same borrower. So is this now just kind of the world's changed and it's really tough for a Relationship lender to be all things to all borrowers.

Well, yes to the last part. It's hard for one lender to be all things to all borrowers. I think that the, the, the incumbent lender, whether that means having previously done this property or having done the most recent deal for most recent similar deal for a client, certainly has an advantage. Legal fees are high. Each deal takes a lot of negotiation. And so when you have a set of existing papers, that is absolutely an advantage. But the markets move so quickly now and the structures of many of these lenders are in various pools that get filled up from time to time, or one. I would say the best example I can give is in a normal functioning CMBS environment, which we're pretty close to now, when we take a deal out to market that's highly regarded, we often find the CMBS proposals come in in three tranches. There's a group that says no just for even with the simplest, most straightforward deal, it doesn't work for them at the time. There's a very large group that is all very similar. We'll say in the pac it was saying that the pricing they're getting to is the low that is going to make sense for any CMBS lender. And then there's a small group, might be one, might be three, who are outliers, who are much more aggressive. And then the challenge for us is to figure out why are they more aggressive and can they really deliver. And I think that what goes into that when what seems like it should be a commodity and everyone should do the same thing, is often the construction of the pools that they're putting the loans into.

So let's go ahead and define CMBS for those who might not be aware.

So commercial mortgage backed securities, it is a structure that was created in the current incarnation essentially in the early 90s. It was Wall street investment banks who realized that they could make several commercial independent commercial real estate loans all on paperwork that was very similar. They could pool them into one set of assets and essentially divide up the collateral rather than simply loan by loan, but into a series of tranched securities where one set of securities was the safest. It would get paid back the first, but get paid back first, that's called the senior. And then there would be a next level that was subordinate and it would get paid back after the senior and then continuing in tranches going to the more subordinate or more junior at higher risk. And that's the basic concept of cmbs. It was attractive to investors at the time. It was pitched because rather than making a single loan on a single asset that was illiquid and had full risk to one property, one market, one property type and one borrower, you could pool multiple loans of. Originally the concept was a variety of geographies, borrowers, property types, sizes, all into one, all into one pool. And so you would have diversification. That's really how it started.

Okay, so let's now talk about the advantages and I don't know if I'd call them disadvantages, but considerations for each of these capital sources. So why don't we go ahead and start with cmbs, because you just defined it. So what would be the advantage for a borrower to work with a CMBS lender and what are some of the challenges or considerations?

Well, let's start with the challenges first, the immediate challenge that comes to mind in the CMBS loan, it's really twofold. One, the loan is made by a certain investment bank who is, who the broker is interacting with and then as soon as possible it is sold off in a security where the counterparty to the borrower is a servicer, it's not a loan officer, it's not a loan, it's not a lender, it's a servicer. And that servicer has thousands of loans that they are processing. And so it's the opposite of an old relationship bank. And we're going to get into relationship banks and balance sheet lenders. And so the first concern is if I have either a problem or an opportunity down the road where I need to interact with my counterparty, the lender, I'm not dealing with someone I knew, I'm dealing with someone who's sitting somewhere in the middle of Kansas or somewhere in the cloud who's not very motivated to help me. The other challenge that is generally thought but not entirely correct is that because CMBS loans are intended to look as similar as possible, that there's no ability to negotiate loan documents, that's really a falsehood. And that it is possible to negotiate CMBS loans, although there are certain constraints. Those are the challenges. So why then would somebody choose to borrow the CMBS financing? That answer changes over time. The original answer was because there was no one else willing to lend on the properties that were being put into CMBS pools. That creation by Wall street of CMBS lending in the early 90s was solving a total lack of. It is still the case often now that a CMBS loan is chosen because it's the only non recourse loan opportunity. That was the case for many fairly Moderate leverage office loans at the beginning of this year. The other reasons are really market driven. There are times when CMBS lenders are the cheapest lenders in the market. There are times when CMBS lenders are the highest leverage lenders in a market. So often it is based on economics being meaningfully different than any of the non CMBS lenders.

Okay, so now let's talk about the banks, the relationship lenders, the balance sheet lenders. So I don't know if you want to start with challenges with them first and then talk about the advantages.

Well, so we're sitting here in November of 2024 and there are certain specifics to the market that make relationship, balance, relationship lending or borrowing very challenging. I think the, in the broader landscape in general, banks lending for their balance sheet have been a very attractive source for the borrowers to whom they were willing to lend because they were the opposite of how we described CNDS lending. There was a, generally a loan officer who was at a bank for a long period of time, who knew exactly what the credit committee would approve, who built real relationships with the borrowers, knew what they wanted, and was able to be very accommodating. And if there was a problem or an opportunity on the loan post closing, then you knew exactly who to call. You'd probably been out to drinks or to a family outing with them and you had a real relationship. And they worked very hard to accommodate things that would be beneficial to borrowers without being damaging to lenders. With the collapse of Signature bank and Silicon Valley and, and First Republic, there was a pullback in lending by other, mostly regional banks and smaller banks was really driven by the regulators. And that has prevented them from operating in the way that all of the loan officers, loan originators, banking professionals who I know want to operate, which is to be very flexible and helpful to deal with, but they've been very constrained. So there is a real, there's a basic requirement for borrowing from banks now that you have to, that a borrower has to put a meaningful amount of cash deposits on account with the bank in order to get a new loan. And not every borrower can, can do that or wants to do that, but I, I hope that's, and think that that's, you know, temporary and will fade over time.

Yeah, so, so again, these can change based on the landscape, the regulatory environment, as you mentioned. But with, you know, that all being said, insurance companies dealing with them, when is that the best execution?

So pros and cons, as with every type of lender, the pro has generally been that insurance companies when they want to be have been the lowest cost provider of capital for real estate. They typically have done that by also being the lowest risk provider. So for a sparkling beautiful trophy style building of any of any asset class with an experienced borrower, borrowing at a moderate leverage level can generally find the lowest cost long term financing from an insurance company. The insurance companies also typically will rate lock upon the signature of the application or term sheet document, the first documentation between borrower and lender and often without significant risk to the borrower. If the deal doesn't close and the rate lock has to be unwound unless the borrower essentially willfully defaulted. Then typically with an insurance company it's a very secure way to rate lock which many borrowers find attractive. The downsides with the insurance companies is that they can be quite bureaucratic. It's not the case with all. Some really differentiate themselves. But as a lender type that would be one of the primary. The primary concerns has been that there's been bureaucracy, it's difficult to negotiate documents and that there's a limited portion of the collateral or of the assets that can qualify for insurance company lending. In my experience over 30 years we've found many insurance companies who are extremely flexible, who function many loan officers and credit committee who think in the way that I describe banks being accommodative and really building strong relationship relationships with. But the reputation has that industry of being less less flexible.

Okay, agency lending benefits there or challenges?

Yeah, I mean agency lending benefit has been at times and this is market driven. They can be the lowest cost provider of financing for multifamily they can be the highest leverage provider as well as I said they were. And I think that when they out compete private and public company but non governmental entities who are competing for a deal it does seem to me to be against the original purpose that they were created for. But these are not government entities and so they are driven by a profit motive. There are many benefits to borrowers to borrowing from the agencies when they're able to. One of the things that you often can do in a Fannie or Freddie loan is after the closing and these are typically long term deals, 5, 10, maybe even 20 year financings. If your income is up dramatically then often you can take a supplemental borrowing from an agency where you can keep your original deal in place but add more money at a new fixed rate. That's often fairly low cost. So that's a major benefit that most other lenders don't or can't Offer.

That's great to hear. So I would say for the last bucket, and this might be a catch all, but if we talk about private lenders, debt funds, where a lot of the bridge lending takes place, and maybe you could kind of define that this might also be a good time to talk about recourse versus non recourse as we talk about pros and cons with various lenders.

Well, the recourse versus non recourse, different, different points. So let's come back to that. I'd say that with. So forget which of the terms you use, but debt funds, private credit, non bank lenders, private lenders, these are all names, sort of catch all names for the groups that don't fit into insurance company, pension fund, bank or agency. And there's been a big range and there is the biggest range that there's ever been now. And it's really everyone else who lends money on real estate. And it ranges from what we used to call hard money lenders, which were thought of as relatively small groups who had raised some capital with an intention primarily to generate the highest returns that they, that they could not so worried about safety, not unwilling to foreclose on a property if necessary. And it ranges to the other end of the spectrum to very, very small, I'll say small level institutional groups, which is pockets of maybe insurance company or sovereign wealth or pension fund money that's been placed into a non bank vehicle where very sophisticated teams are set up to lend money in large amounts. And some of the largest loans that are made now on a floating rate basis come from these debt funds or other groups that don't fit the other categories. And it's a huge, huge portion of the real estate financing that's gone on in the last few years has come from groups that you would call debt funds or in this catch all category. So it's not a throwaway. We could easily have started with it as the most important, important source of financing in the market.

And so not to make a generalization, but it sounds like, you know, if you're looking for a higher loan to value also. I mean, depending on the asset class, depending on the occupancy, I would say generally it'd be difficult to get a vacant property financed by a bank. Right. Because they're looking to lend on income. So when you have this whole range again of different alternative lenders, if you have an asset that maybe doesn't fit into a box per se, that might be, you know, the right type of lender, especially if you're you're looking for.

I think there's a basic leverage. Yeah, there's a basic construct of cash flowing properties and non cash flowing properties. Right. And those are. So there are a number of ways that we could go through and differentiate within the market. So cash flowing properties, CMBS loans, that's what CMBS loans focus on that for the most part insurance companies and pension funds do as well and in many cases, especially now banks do. For the non cash flowing properties, which could be land intended for development or buildings that are empty with the intention to fill them up, maybe by converting them, maybe by keeping the use the same, then those loans typically fall into what would be the, what are we going to call it, the debt fund space, the private credit space, the bridge lending space. And that is. Now this is confusing because some of the major insurance companies have formed their own debt funds. So you could have the MetLife was one of the first in my recollection to insurance companies to say we are very good at lending on assets. We are knowledgeable enough to do this not only on the safest assets, but to find the good assets that we believe are at the quality of what we do, but are simply at a different point in their cycle. And so many of the groups that were formerly very sort of staid institutional groups, now our investment managers representing a whole lot of different funds. So it makes our job both more complicated and I think more enjoyable to have less segmentation of the market than has been in the past. Okay, great.

So now let's talk about how lenders use indexes, spreads to establish the borrowing rates. And I think not to get into the whole macroeconomics of this, but again we're here November 24th having finally had a rate cut by the Fed. And yet low and behold, the 10 year treasury goes up, as do some of the borrowing rates. So what are these various types of lenders? What are the indexes that they are lending on? And then you know that spread is as important in what that ultimate interest rate is in that consideration.

So we couldn't possibly cover every nuance. So let's stick to the simple and macro. Fixed rate loans are typically. The interest rate on a fixed rate loan is typically expressed as a credit spread, a number of basis points over the treasury index. So that refers to the United States Treasuries as the index rate. So if you're making a 10 year loan, when a lender looks at their risk, they say what is the lowest risk investment I can make for 10 years? And it's thought to be the 10 year Treasury. And so if I am going to make a real estate loan instead of simply buying a Treasury, which means lending money to the US Government, if I'm going to make that real estate loan, how much more yield do I need to receive on my real estate loan than what I would have gotten simply by buying the Treasury? And that differential is the credit spread. So if a lender says I want a credit spread of 2%, I want 2% higher than what I could get on Treasuries. That would be expressed as being a loan offer at 200 over treasuries. So what's implied in that 200 is 200 basis points. That's the same as 2% and treasuries it's implied, although not always the case, that the specific treasury security that that lender is looking at is the treasury bond with the same length or maturity as the loan. So that's the basic way that fixed rate senior loans are priced. On the first floating rate side, the index is now sofr, which was the replacement to Libor, which was the index that was used for most commercial mortgage loans over the last 20 years. Somewhat similar concept in that the rate that banks can essentially get money from the government. None of it's as simple as all this, but the basic concept is that is the rate at which the banks could get money without taking risk. And so how much more yield do they need? Expressed as a credit spread described the same way but priced over sofr, that would be a typical floating rate structure. In a fixed rate loan, the borrower and the lender agree first on a credit spread over Treasuries, then on a date when the rate is going to be locked. And when the rate is locked, then the rate is fixed. So we rate locked the deal last week that had a credit spread of say 130 basis points over treasuries. If the 10 year treasury was a 10 year loan, if the 10 year treasury was 4.4.5% at the time we locked, then that rate would be locked at 5.8%. And that means that that borrower is paying that lender interest of 5.8% for the entire 10 year loan and amortization.

As opposed to interest only.

So amortization was the. When I was first learning all this, so when I got started, amortization was a concept I found extremely challenging. And I'm not sure why, but I have found it with other. I'm mentoring a lot of students at Cornell now and it's also something they Struggle with. So the two basic concepts in a loan or a few basic concepts. How much is the bank going to lend to the borrower? When will the bank be repaid? Will it all be at once, at the end or along the way? And what interest rate, what profit does the bank want to make? What yield profit rate? It's all the same, meaning the same thing. How much does a bank want to earn in order to put this money out on that basis? That concept of the lender getting paid back and when is a concept of amortization. A term that's used is principal. So if I talk about $100 million loan, that's a loan with $100 million principal amount. And the question is how and when does the principal get paid back? And the paying back of principal is amortization.

What about the debt service coverage ratio? Any other terms that lenders are using to size up a loan amount?

So when lenders determine how much money they're willing to lend on a property, there are a number of metrics that they use. The primary ones are debt service coverage ratio. Another is loan to value, and another is debt yield. Loan to value is probably the simplest. That's a comparison between the value of a property and the lower amount that the bank is willing to lend. So if a.

You said value, not loan to cost. Because you know, sometimes borrowers think, oh well, you know, I'm buying the property for $10 million. So that's what the value is. But of course that's subject to what an appraiser is going to.

Well, loan to cost. And loan to cost is another important one as well. So loan to value is one that has typically been used for floating for cash flowing properties. So if, if James, if you sell a property for $100 million, it's cash flowing. And a lender says, I am willing to lend a 70% loan to value based on that test, only they would be willing to lend $70 million. Why is that less than, why are they only willing to lend less than the $100 million? Because they, the lender is trying to be in a safe position earning a return that's lower than what an owner is going to, than what an owner is going to receive. Loan to value, if it was used as the only sizing test, would not protect a lender for changes in interest rates over time. And so what lenders? Another metric that lenders have used for a very long period of time is debt service coverage ratio. That's a comparison between the net income at a property, the amount of money that's available to pay debt service and the debt service amount. So if we had a property that had a $1.5 million NOI and a lender, after coming up with their fixed rate, determining the fixed rate, and the principal was going to be receiving $1 million in debt service payments a year, that is a loan with a 1.50 debt service coverage ratio. So the income is 1.5 times the debt service that's owed. That was a metric that was used for a long period of time. But when rates dropped significantly, then when the debt service was very low, lenders said, oh, not lenders, but borrowers said, oh, since the interest is so low, I should be able to borrow a lot more money because I can achieve a higher debt service. I can achieve the same debt service coverage ratio on a much higher loan amount. And so a new metric was formed about 10 or 15 years ago called debt yield. Debt yield, although it's confusing because it has the word yield in it, it is not an indication of the price of a loan or the cost of a loan. It is a sizing metric, and that is the combination between the loan amount and the net income amount. Okay, so a deal with a 10% debt yield could have any interest rate. It could be a 3% interest rate, a 5% interest rate, an 8% interest rate. What the debt yield means is that comparison between the net income and the loan amount. So a property that has $100 million loan and a $10 million net income has a 10% debut.

Perfect. I love how you explain these things too, Scott. I know there's a lot of terminology, so bear with us. And the next time your Cornell students ask you for an explanation, they could just listen to this episode a couple times. And by the way, in the Insiders Edge to Real Estate Investing, there's a whole chapter on this. There's also a glossary that Scott helped provide that terminology. So there is now transcriptions for these. So you can certainly see it in writing, but it's also there in the book for you. Okay, so just a couple more terms and just wrapping things up now. So when you're negotiating a new loan, looking at options, you know you've got that term that you've established what happens at the loan maturity when talk about how you know, or if there's a floating rate that. That sets, maybe talk about how that works.

Sure. So one of the important terms in a loan is that is negotiated upfront, but really the borrower determines how long a loan they want at what point do they want to have? Are they comfortable have the obligation to repay the loan? And so those loan terms can range from let's say as short as one year to, to as long as 20. In commercial real estate, the typical term for a fixed rate loan on a fairly stable property would be either five or ten years, but some rarely is it shorter. Sometimes it is longer. On floating rate loans, which are generally for properties in transition, that could be a construction loan, it could be a property that's being renovated or the use is being changed, then a typical term there is somewhere in the three year range. So, and a typical term structure is called three plus one plus one. So what does that mean? That means it's an initial term of three years with a borrower option to extend the loan for one year two times. With those options, generally there are some hurdles that a borrower has to hit in order to qualify for those extensions. And that could be reaching a certain income level or debt service coverage level or often there's a fee to be paid, but there's a huge variety. So there are some loans that are one plus one plus one. It's a big range option, generally refers to the borrower having the right to make the loan longer, subject to hitting certain thresholds.

And this might be a good time also to talk about prepayment penalties. So I would imagine if you're having shorter term bridge financing, yes, it costs more money. There might be points going in and out. We could talk about that as well. But you might not have prepayment penalties if you pay early. Whereas if a bank makes a loan and they've taken the time and effort to underwrite that and you pay it off early, there might be a penalty to do that.

Well, so there are a few fees in that regard. So let's start with fixed rate loans. In a fixed rate loan, the borrower and the lender are deciding at the beginning on a single rate that will not change that the borrower agrees to pay to the bank every month until the end of the term and the lender agrees to accept from the borrower every month until the end of the term. And that's the bargain that's made between them. So that from borrower's perspective, that is a way to ensure that they know how much they have to pay and that they will, regardless of what happens in the world with interest rates, they will not be subject to increases in what they have to pay to the lender. Well, from the lender's perspective, it's a source of Income that they can count on to do the things that they do in their business. So if a rate is fixed for 10 years and after 7 years the borrower says I'm ready to pay off this loan, that might be very good for the lender, might be very bad for the lender, depending on what the lender is going to be able to do with the money when they receive it. And so prepayment penalties are a concept in a fixed rate loan that allows the lender to continue to receive the benefit of the bargain they struck, that they would receive that fixed rate for the whole 10 years, while also allowing the borrower the freedom to move into, to release himself from the obligation to continue paying on a monthly basis or even to continue owing the property. And so the basic concept behind prepayment penalties is a make whole prepayment penalty. And that is making the lender whole to the bargain that they set by providing one of a couple things. When the lender wants to reap when the borrower wants to repay the loan, and that could be either in a yield and maintenance make whole prepayment structure, that's a payment, it's just a calculation and a one time payment upon the repaying of the loan early and then the fees and structure. And it is a substitution of collateral where the lender is willing to release the property, the mortgage on the property as a collateral for the loan in exchange for receiving Treasury, a basket of treasury securities that provides the lender with the same level of value back in the loan and the same cash flow stream they would otherwise have gotten from.

The property, and points that are upfront for the loan origination or on the exit. And again, you typically see this more in bridge type loans, but kind of let me talk about that piece to the negotiation as well.

So when a borrower lender agree on the cost to the borrower or the yield to the lender, for the lender making that money available for that period of time, the lender can be compensated in a few ways. One, as we've talked about already, is their credit spread over the index. So that's the interest rate or the coupon. And another is fees, origination fees or points. It's the same thing. Origination fee and points are the same concept expressed two different ways in order to confuse new people in the industry. But that is a payment that the borrower is making to the lender that instead of paying it over time, they're paying it all upfront. Why it was constructed in that way. I guess lenders have had. It's good, it's good to be the king. It's good to have the money, as Mel Brooks said, until they're able to get partially paid at the beginning of a loan. The other fee that we haven't talked about are exit fees. An exit fee is different than a prepayment penalty. Prepayment penalty is a compensation to the lender for the borrower having the flexibility to repay the loan early. An exit fee, similar to an origination fee is simply a cost of doing business that the lender is able to inflict on the borrower. It's paid at the end of the loan on the way out. It's worth a borrower generally. Well, if the payment amount is the same and it's in the future, then that's generally considered to be better than having to pay it upfront because of present value. Okay.

One other major consideration when borrowing is whether or not there's recourse or not or partial recourse. And there's different levels of that as well. And I mean, again, we could talk about this for hours, springing guarantees this and that. And I think if you're listening to this long, you understand, understand the importance of having an advisor and intermediary because you could, you could see this gets pretty complicated quickly. But just, you know, how do you look when you're advising your clients on recourse versus non recourse and kind of the different levels of that?

Well, I would say generally this is a family show and now you've started using dirty words. So recourse is a concept that borrowers don't like. And so the basic concept is guarantees and it's in the event that the property is worth less than the mortgage and therefore there is not a source to fully repay the loan from the value of the asset who takes the loss. And in a non recourse loan, that means that the lender is taking the loss in that situation. At the simplest, that the lender and a non recourse lender is making the bet that the property will perform sufficiently over the entire life of the loan and be worth enough at the end that the borrower will either be able to find the new loan to fully refinance the old principal, or that it will be able to be sold by a sales broker like James for at least the amount of the mortgage so they will be fully repaid. But unfortunately, sometimes that's not the case. And a non recourse loan is where only the borrowing entity is responsible for the repayment of the loan and the borrowing entity only has the property as its only asset. And so if the property is sold for less at the end of the day, then the lender takes the loss in a recourse loan. Then the lender is saying in addition to having the mortgage on the property as collateral, in addition to that they need someone from the borrower's side to guarantee that in the event that the property value is not sufficient to repay the loan, then the lender has the right to pursue the other assets of, to make the lender whole for everything that they're owed. So that is obviously a very, very important negotiation and extremely important point for a borrower and its principals to understand in making a loan. The traditional, for the last 50 years borrowing on cash flowing assets has been non recourse borrowing, meaning that there were plenty of lenders to take the risk that the property values would be high enough. This is the reason why lenders have a loan to value constraint. So when the lender says my maximum loan on this property is 70% loan to value, it's another way of saying I want to make sure that the property value could decline by as much as 30 before I would lose any money on the, on having made this loan. The, the recourse comes in different shapes and sizes. So the, it's challenging to even know where to, where to start. There's a lot to it.

But we, I mean, yeah, I, I think for an overview and just understand the concepts, this has been super helpful. And Scott, you also have a really great way of taking complex topics and really simplifying them. So we certainly appreciate that. Scott, are there any other key terms that when you're negotiating financing for a borrower that we've missed here? I mean we, we've talked about obviously the rate, we've talked about term, we've talked about amortization, we've talked about points, we've talked about options, recourse, what, what else is important when you're negotiating alone?

Well, I think for the 101 class or 1000 class for right for my kids generation, you hit on the big one. On the other hand, each the loan agreement on a, on a fairly straightforward commercial mortgage is probably 90 pages long and there's nothing in it that's the, that's not relevant. And so, and, and so I'm lucky to work with my dad who's been in the business for 55 years and says every loan we've ever done there's something he's never seen before. And I think that we bring that, that experience into loan document negotiations and find that on each loan we're negotiating something different on the, on the one I hope we're funding now. It is, it had to do with some of the specifics of the recourse guarantee in unusual situations. But. Right. But it's, there's always something different. Yeah.

And I would imagine also, you know, what is the business plan and what are you intending to do the lender wants you to execute on that business plan, not just go do something entirely else. I know certain provisions with certain lenders on release prices. If again if you're selling condos for example, or for major leases that you have to achieve a certain level. So I mean again, a lot of different.

Yeah, there's one that's been important in a couple of the deals that, that you're selling and especially now is the question of assumption. Does the, does the borrower. So many of the loan, many of the fixed rate loans that exist now have interest rates that are much lower than the rates that are achievable in the market today. And so when new buyers are coming into properties, if they have the ability to keep the existing low rate financing on the property is as you know, that that could increase, that could double the value of a property now. And so one of the critically important clauses now that maybe wasn't focused on so much 10 years ago is the assumption clause. What are the banks? Under what circumstances is the lender required to allow a new purchaser to become the borrower versus under what circumstances is the borrower required to repay the loan if the property is sold? That may be the most important clause in any existing fixed rate mortgage rate now.

Wonderful. Well Scott, this was awesome. Thank you so much. A lot of information here. So I hope our audience is taking notes or at least again they know who to follow up with on these questions. But a lot to know here. But certainly your understanding of these principles, the different types of capital sources, I mean this is a critical piece to gaining that insider's edge to real estate investing. So as always we appreciate your joining us. Found this helpful. Again I would recommend sharing it with a friend. Thank you. That's the best way really to get the word out there. And as always you go tojames nelson.com. that's where you can find show notes, that's how you can find how to connect with Scott if you want to have a follow up on this. But thank you again for joining and look forward to the rest of the series with you.

Scott, thank you for doing this. I do too.