Even at a 6.25 exit cap the year three refinance won't clear on this 148 unit deal

Question

Here is a 148 unit 1996 vintage deal in a Sun Belt submarket about 30 percent through its supply overhang, worth underwriting as a room. Price 21.6 million, 145,000 a door, in-place NOI 1.19 million, so 5.5 going in. The plan is 92 units of classic interiors at 9,500 each targeting a 165 dollar premium, plus roofs and a re-stripe, so 1.15 million of capex. Debt is quoted at 65 percent of cost with a five year term, rate in the low sixes, interest only for two years. Year one DSCR pencils at 1.18, which the lender will size to, barely. The problem is the exit. Hold the exit cap at 6.25 so nobody fools themselves, and at stabilized NOI of about 1.52 million that's a 24.3 million value, so 2.7 million of value creation against 1.15 million of capex plus fees. The refinance test in year three is where it breaks. If rates hold, the takeout at 1.25 DSCR on stabilized NOI barely covers the existing loan and returns nothing to investors, so the whole thing depends on sale. Is it wrong to treat a five year term as short here, given absorption may not cross over in this submarket until late in the hold? And is anyone underwriting a supply-lag extension into the lease-up curve rather than into the exit cap?

Rena Expert · Accepted Answer

A five year term against a submarket that may not see absorption overtake deliveries until the back half of your hold is the tightest thing in your model, tighter than the exit cap. You've been careful on the cap and then given yourself a loan that matures roughly when rent growth is supposed to start compounding. If the crossover slips a year, you're refinancing or selling into the exact conditions you underwrote against.

On the lease-up curve question, yes, that's the more honest place to put the lag. Pushing it into the exit cap is a single blunt adjustment applied at the end, and it lets you keep an unrealistically fast trade-out schedule in years one and two. Model it where it happens instead. In an oversupplied submarket, a 165 dollar premium on a renovated classic unit competes against new deliveries offering concessions, and the practical result is longer days on market and premiums that arrive at 110 or 130 for the first stretch. Run your 92 units at a slower turn pace, say 22 to 26 a year rather than 30 plus, hold the premium at two thirds of target for the first eighteen months, and see what happens to the year three refinance test. That's the same information the exit cap adjustment was standing in for, in a form you can actually manage against.

The DSCR at 1.18 sized on interest only is the part I'd stress hardest. When IO burns off, the payment jumps to amortizing and your coverage drops before your renovated rents are fully in place. Get the lender's amortizing DSCR at month 25 in writing along with the actual covenant, because a technical breach on coverage can trigger cash management and sweep the distributions you were planning to pay.

One more thing on the expense side. At 145,000 a door in the Sun Belt, insurance and reassessed taxes can move 150,000 of NOI on their own, which is a tenth of a point of cap on your exit value. Get bound quotes before you're hard, not indications.

monica_tran3 · Answer

The re-stripe and roofs at that vintage rarely stay at budget once the first roof comes off and the deck rot shows up. On 1990s frame product it is common for the roof line to land 40 percent over the estimate because the scope moves from overlay to tear-off on three buildings the moment the decking is exposed. Your 1.15 million has no contingency in it that I can see.

derekj19 · Answer

What does cash management actually mean in practice? Is that the lender holding rent receipts, or just blocking distributions?

joe_delgado5 · Answer

@derekj19 typically a lockbox where collections route to a controlled account and the lender releases operating expenses and debt service, distributions last. Read the loan docs for the trigger level, it's usually a DSCR test measured quarterly on a trailing basis. @luis_carrera I'd be asking for a five plus one plus one with extension tests you can actually hit rather than trying to win on the rate.

carlos_nunez · Answer

Ninety two units of interiors at 9,500 out of 148 total means you are touching nearly two thirds of the building. On a 1996 property that is when you find out whether the panel boxes and the water heater closets support what was drawn. A scope at that depth tends to grow by a line item nobody priced, a shutoff valve replacement across every stack is the usual one, and that alone can run six figures on a much smaller property.

sonia_alvarez · Answer

The extension options @joe_delgado5 mentions are where to focus, and read the conditions carefully. An extension that requires a 1.35 DSCR or a fresh appraisal at a minimum debt yield is closer to a hope than an option. Debt yield is NOI over loan amount, and lenders have been sizing to it more than LTV, so ask what debt yield they are using at 65 percent of cost and back into what NOI you need at maturity. If that number is above your stabilized projection, the deal has a refinance problem you can see today.

tylerbrooks9 · Answer

Worth putting the plain version of the question on the table. If the exit cap and the rent premium and the loan term all have to go your way, is a deal like this really the one to buy at what people are calling the bottom, or does the bottom mostly reward whoever has cheaper equity and no maturity clock?

Even at a 6.25 exit cap the year three refinance won't clear on this 148 unit deal

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