Commercial Investment Real Estate

JAN-FEB 2015

Commercial Investment Real Estate is the magazine of the CCIM Institute, the leading provider of commercial real estate education. CIRE covers market trends, current developments, and business strategies within the commercial real estate field.

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15 January | February | 2015 CCIM.com original loan while still adhering to legal and industry standards. Strict guidelines govern how much cash may be included, month-end balances have limits throughout the life of the loan, and a large universe of bonds exists from which to construct the portfolio. Timing Defeasance Defeasance can be a preferred option in many dif erent market environments, the most obvious being when interest rates are falling and borrowers can obtain lower interest rate loans on their properties by ref - nancing. However, defeasance can also make sense in a higher interest rate environment when borrowers have enough equity in their properties to cover the prepayment penalty. While penalties still range from tens of thousands to tens of millions of dollars, many borrowers can save considerable amounts by defeasing in today's lending market. Defeasance presents the opportunity to move interest rates from 5.5–7.5 percent to 3.5–4.5 percent, while of ering protection against probable interest rate increases over the next few years. In many cases, defeasing today means negating interest rate risk at a minimal cost. For example, for a borrower with an orig- inal principal loan balance of $10,000,000 originated in June 2007 at a 6 percent interest rate with a 10-year term, the potential cost savings from defeasing now will be approxi- mately $562,094.63, based on current interest rate forecasts. As illustrated in the graphic below, while the total cost to defease today is approximately $1,040,000, total interest pay- ment savings from locking in a new 10-year loan at 4 percent interest today rather than 5.5 percent interest in 2017 will be approxi- mately $1,600,000, resulting in a net prof t of approximately $560,000. Should interest rates move above 5.5 percent by 2017, these savings will be even more substantial. Moreover, for borrowers looking to lower their defeasance costs by waiting for yields on Treasurys to rise, it should be noted that this strategy will most of en have only a min- imal impact on costs. For example, should the borrower choose to delay defeasance until the relevant Treasury rates increase by 10 basis points, the defeasance savings will be only approximately $21,000. Obviously, while these savings are certainly helpful, they pale in comparison to the potentially hun- dreds of thousands of dollars in increased interest costs that borrowers risk incurring by delaying their ref nance. Indeed, most borrowers view defeasance as a Treasury-rate game, believing that they should delay their defeasance as long as pos- sible to lower their costs. However, as dem- onstrated by the savings in the graphic below, the rewards associated with defeasing today can of en outweigh the rewards of delay. Eitan Weinstock is the senior defeasance ana- lyst at AST Defeasance in Los Angeles. Contact him at eweinstock@astdefeasance.com. DATE SAVE THE CCIM SPRING BUSINESS MEETINGS March 22 - 25, 2015 CHICAGO, IL DEFEASANCE SAVINGS SCENARIO Original loan amount – $10,000,000 term – 10 year Interest rate – 6% amortization – 30 years Defeasance date: February 1, 2015 Maturity date: June 1, 2017 Defease Now DV01 $2,119 (dollar value of a basis point in terms of bond yields) Defeasance cost $1,040,451.03 New loan interest @4% $3,672,181.24 Total cost (10 years) $4,712,632.27 Wait Until Maturity Remaining interest $1,065,712.83 New loan interest @5.5% $4,209,014.07 Total cost (10 years) $5,274,726.90 Potential cost savings by defeasing now $562,094.63

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