We have a seller who want us to build in a pre-payment penalty on a park we are buying from them on terms. I wanted to get a handle on what the forum’s consensus was on defeasance terms and structure. Also, has anyone else run into to this and what was your story/strategy? This is a great deal for us in terms of CAP rate and upside (we would usually say no to this request). We could potentially take the seller out in year two conventionally without this 10 year stipulation. What are your thoughts?
What kind of prepayment penalty is he looking for? My seller wanted 5 years but we settled on two which is almost 0 as its a turnaround park that will take 2 years anyway. I had considered offering a declining penalty if that didn’t work. I.E. 5% year 2, 4% year 3 and so on.
What worked for me was that I explained that I had to have the option to refi because of the cash outlay that was needed. I explained that I probably wouldn’t but at least needed the option to refi.
I’m not exactly sure what she is looking for on this as my partner handles this one. Her biggest concern on a sale was taxes so I’m getting the impression that her CPA suggested building this in to keep us from refinancing/selling within a certain time period. We are fine with that because that really wasn’t our plan anyways. I’m thinking that a declining penalty by year might be the way to go here, as you suggested. We will likely make sure it is assumable too. Any thoughts on a suitable 10year declining schedule?
Hey Charles, any more details yet?
If I were looking to buy this flip off of you a 10 year prepay would be a huge turn off.
What does this do to a cash out or exit strategy? If you want to cash out refi that’s out, if you want to sell it’s much harder, even if the loan is assumable. If I have to assume the loan and you increase the value of the park by 50% that added to your original down payment is a lot of cash to come up with to assume a loan.
Just one man’s opinion here. If it’s a buy and hold its no biggie but you’re married to it for 10 years.
I’m curious as to what Frank and the others think but that’s my opinion as I was once in your shoes and thought it through carefully.
By the way, there’s a park for sale in FL right now that the flipper can’t sell because to assume his seller note you’d have to put $800,000 down to assume the note on a 1.6M park
Below is the exact wording we offered. One of the issues is that we want to make this simple on both of us so we don’t have a fight on our hands later on with it. We are fine with keeping the financing with her for the next 5-10 years.
Adjustable Rate Note:
- 5 yr fixed
- ARM (adjustable rate mortgage) will be tied to the LIBOR index
- First adjustment will take place 5 years following the date of when the first payment was due. Subsequent adjustments will take place every other year on the same anniversary date.
- Margin 2.25%
- Floor 6% (rate will never go lower than original rate)
- Cap: 1% on each adjustment
If the prepayment occurs on or before the first anniversary date of the loan, the prepayment penalty will equal five percent (5%) of the principal amount prepaid.
If the prepayment occurs after the first anniversary date, but on or before the second anniversary date, the prepayment penalty will equal four percent (4%) of the principal amount prepaid.
If the prepayment occurs after the second anniversary date, but on or before the third anniversary date, the prepayment penalty will equal three percent (3%) of the principal amount prepaid.
If the prepayment occurs after the third anniversary date, but on or before the fourth anniversary date, the prepayment penalty will equal two percent (2%) of the principal amount prepaid.
If the prepayment occurs after the fourth anniversary date, but on or before the fifth anniversary date, the prepayment penalty will equal one percent (1%) of the principal amount prepaid.
Prepayment penalty shall not apply if the prepayment occurs after the fifth anniversary date
That doesn’t look too bad. Depending on the park I think most people could live with that.
The inmates are running the asylum!!
Are you all nuts?
If you are the buyer and you payoff the loan before the term there should be a pre-payment DISCOUNT!!
And it should be stated as such in the note itself.
Defeasance is for the CMBS lenders and their ilk.
Not private parties.
Well, our going in CAP rate is 13 and there is upside. The park is fully stabilized, but the seller demanded that we let her seller finance it and that we don’t refinance within the next 5 years. It was something we could live with.
The park I bought will be worth $1M more in 5 years than I paid for it. It’s a turn around and will take 3 years to establish a sound track record good enough to refi anyway. So essentially I gave up nothing making the seller think she got something.
So where’s my downside? I gave a worthless 2 year prepay penalty and will make about $1M in 5 years.
Never say never