With interest rates hovering below 3.5%, many co-op boards are considering refinancing their underlying mortgages. Andrews is currently working on 21 refinance packages.
What factors should they consider?
Boards should take into account more than the interest rate when deciding between multiple offers.
- What differences in loan terms exist? To properly assess the benefit of one option over another, similar terms need to be obtained from the competing banks. Does one bank offer interest-only while others amortize 10-year terms over 30 years or fully amortized? Interest-only may be easier to budget in the near term, but over the life of the loan, no principal would have been repaid.
- What are the closing costs? Lawyers, due diligence reports, broker fees, mortgage recording tax, commitment fees, and other considerations must be factored into the equation of which loan option is best, as well as factoring how much needs to be borrowed (whether to incorporate those costs into the loan or to self-fund.
- But perhaps the most important factor is prepayment penalty. It is difficult to plan for events 10 years away. An unexpected capital project and/or additional local law regulations may require a Coop to borrow additional funds before loan maturity. Does the bank have strict or lenient policy? Sliding scale penalties where the % penalty is lower as the loan progresses year after year is common. Some banks may allow up to 10% prepayment without penalty each year. Another buffer to protect a co-op for occasions where additional funds are necessary is to also take out a line of credit at the time of the 1st mortgage. This oftentimes would serve a sudden requirement for capital funds, mid-term of the loan, without requiring the refinance of the underlying mortgage.
Ask your managing agent how these factors weigh in comparing multiple offers.
What has changed?
Boards should know the process is longer than 90-day turnarounds on loans. With banks, brokers, legal counsel, and other 3rd parties working remotely, the process is taking longer – closer to 120 days. Furthermore, PPP loans have inundated banks and depleted human capital to focus on refinances. If your current mortgage is maturing in the first half of 2021, now is the time to commence the refinance process. Lenders are also becoming more strict on candidates. Many have implemented thresholds before they will consider a Coop loan. $3M is a typical floor to receive the most competitive rates. In addition, many require 20+ units, less than 10% sublet, and no significant arrears older than 30-60 days. For loans, less than $1M, there are fewer banks in the market, and as such rates are higher. Situations have occurred where banks who are holding the current underlying mortgage decline to make an offer for refinancing because their thresholds have changed since the loan was originated years ago.
Boards should refinance the Coop’s underlying mortgage as a way to pay for capital projects or lock in historically low rates. It is not recommended to borrow money to cover operating income shortfalls. For that matter banks typically would not entertain lending money in a case where the operating budget is not cash-positive. Operating budgets affected by decreased commercial rent income or other challenges must be addressed before a bank will consider a Coop a financially worthy risk. A 2021 budget should be drafted taking into account proposed mortgage financing expense and increasing real estate taxes. Banks typically look for a 5% contingency as another method to alleviate any concerns a loan will risk default.
Understandably, this is a daunting task for a Board to make an informed decision. Please reach out to Stuart Smolar, Senior VP, or Edmund Lew for a thorough review and discussion on your financing options.