While adding value to your investment property is critical to maximize returns and often to protect your downside risk, it is arguably even more important to structure the right deal in the first place. The key components to structuring the right deal are the price, debt, and equity. How to Structure the Perfect Real Estate Deal
PRICE
Price is somewhat more straightforward and requires proper and diligent underwriting to uncover the appropriate price to pay for an asset. Underwriting involves many moving parts, so to learn more about underwriting read The Definitive Guide to Underwriting Multifamily Acquisitions.
DEBT
Virtually all commercial real estate utilizes debt to enhance returns and improve deal structure. Debt must be conservatively factored into one’s analysis of structuring the best deal. Debt is one of the largest factors when it comes to risk, so it is important to understand how the leverage, interest, and term of the proposed debt structure impacts the overall risk of the investment.
Floating Rate Debt vs Fixed Rate Debt Floating rate debt and fixed rate debt also carry their own respective risk factors. Floating rate debt can negatively impact cash flows if interest rates rise during the ownership of the property. Meanwhile, fixed rate debt can adversely affect a sale since fixed interest rate loans usually have a very strict and expensive prepayment penalty.
Higher Leverage Loans Higher leverage loans may increase projected returns but also increase the risk of losing money in a downside scenario. Higher leverage is usually accompanied by a higher interest rate, which negatively impacts cash flow and could put the investment in a negative cash flow scenario if the business plan targets are not achieved.
Loan Term Finally, the term, or duration, of the investment’s loan is also a risk factor. A shorter-term loan can create a scenario where the loan becomes due when the property’s value makes it unable to obtain new financing to pay off the existing debt. A situation like this can force a sale at the worst time, which may cause equity investors to lose some or all their initial investment.
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