The Truth To Interest Rates & Cost Of Capital

www.BHCLMerchantBankers.com

It is hard for me to calculate the number of applications I see in a month where the applicant has unreasonable expectations about interest rates and cost of capital.

I then see the seasoned applicant that has a more realistic approach to what it will take to finance his request.

He is the guy I am after 100% of the time.

I truly strive to do business with high quality clients and seasoned professionals that either know what they don’t know or have the capacity to dissect and understand the marketplace and its expectations.

However I want to provide you with a clear and distinct guide to unravel the mystery of the interest rate and cost of capital. So, here we go…

First of all, rate for real estate financing is primarily affected by;

1. Cash in 2. total equity (LTV)3. Credit and past and or future performance.

Let’s break that down...

Let’s say you are only capable of putting 5% down on a million dollar property.

You can expect that the rate will begin to be elevated higher than prime.

Then add to the fact that that 5% along with the total value of the asset is only reflecting a an 90% LTV, by appraisal, interest rate is going to escalate even more.

Next, let’s say that the asset has not performed.

(NOI) well in the preceding years or improvements are not going to make the needle jump to any great extent then you can expect that the interest rate is going to climb yet again.

Finally your credit is in question and you have not had a great last three years and it shows on your credit report.

You can expect that the interest rate is going to increase proportionately.

Looking back you can see that this is not the ideal application. But you want to move forward.

So now you are looking over the commitment letter and it indicates you are going to be paying an annual rate of 18% along with 5 points up front and closing costs of another $15,000!

Now add in the appraisal cost, miscellaneous costs and third party reports and you absorbed another $8,000.

You really need to ask yourself…

 • Is this asset really worth it?

• Is this asset going to perform in light of the fact I am paying out the nose to get it financed?

• Can the rate and cost of capital (all other costs added together) really allow me to generate a return?

These questions must be asked. And if you can generate a return with all considered as outlined above then so be it.

But with all in as described above I think it would be an uphill battle.

Now Let’s Reverse The Story

You can commit to 30% cash down.

You then have a 65% LTV all considered inclusive of the appraisal results.

The past performance of the asset appears to generate a strong NOI and your proposed improvements will make the needle jump up a bit more and improve the NOI yet again.

Your credit is in the 700’s and you have strong secondary income.

All these factors make you a PRIME borrower and candidate.

Your commitment letter indicates you are going to pay 5.75% annual interest and one point at closing.

Then the other costs are incidental. It all fits together.

These combined factors make it all worthwhile.

It is a good and sound decision to go forward.

Now you may fit somewhere in between these two examples. You still need to ask the same questions as I mentioned above. But the moral of the story is that not everyone is a PRIME borrower.

You should and need to realize that interest rate and cost of capital greatly affect the decisions you make about asset acquisition.

You really need to be realistic about your expectations as to interest rate and cost of capital.

Just because you think you are acquiring a great asset does not mean that you can ignore all the other factors related to financing.

So let’s look at a checklist of factors as part of the guide.

A) How much cash can I afford to put towards the acquisition? 5% 10% 20% 30% 40% (the higher the number the lower the rate) B) What will my total LTV be? 90% 80% 70% 60% ( the lower the number the lower the interest rate) 

C) How can I improve the NOI on the asset? 2% 5% 7% 10 % (the higher the number the lower the interest rate) D) Will my credit withstand scrutiny? 500 600 700 800 (the higher the number the lower the interest rate) 

E) In the end with all cost of capital and interest rate is the acquisition going to generate adequate returns?

Cost of capital 10% 20% 30% Interest rate 5% 6% 7% 8% 10% 12% 15% 18% 20%

Now You Can See A Clear Pattern

This is the matrix of factors that indicate where you stand in the marketplace of real estate asset financing.

Use this as your guide to make sound decisions.

Use this as your guide to measure what kind of applicant you are.

And ultimately use this as your guide to acquire attractive and sound real estate assets.

Contact us today and one of our experienced bankers will be available to assist you with evaluating your next commercial real estate purchase.

Direct: 505-265-5123

http://www.BHCLMerchantBankers.com

This presentation was prepared by George Lovato Jr., Principal of BH Capital Ltd. and BHCL Merchant Bankers.

Contact Information

Office: 505-265-5123

Address: 2527 Virginia St NE STE FAlbuquerque NM, 87110

Website: www.BHCLMerchantBankers.comwww.BHCapitalLtd.com

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