Sponsor wants to buy the rate down instead of taking a lower purchase price

Question

Reading a 240 unit deck where the sponsor is paying about 2.1 points into a rate buydown and an interest rate cap that runs three years. The alternative they say they negotiated was a purchase price about $1.8m lower with the rate left alone. Same total check either way, roughly.

The case for the buydown is that it protects year one and year two DSCR while the submarket still has 900 units delivering, and it keeps them off a lender watch list during the worst of the absorption gap. Coverage pencils around 1.18 with the buydown and something like 1.02 without, which is the difference between a distribution and a suspended one.

The case for the lower price is that basis is permanent and rate relief burns off. At 20 to 30 percent below the 2022 peak, the whole argument for buying now is basis, and paying it out to a lender to smooth two years of coverage feels like buying comfort. If you exit on a cap rate, $1.8m off the price is straight equity. If they have to refinance in year three anyway, the cap expiring lands them in the same place with a worse number on the recorded price.

Twelve years in construction trained me to grab the permanent thing ahead of the temporary thing, but I've watched enough deals die in month fourteen of a lease-up to know that surviving is not free either. Confirm any cap or buydown pricing in writing with the lender, it moves.

Which way would you take it.

aaron_fitz10 · Answer

The part that decides it for me is whether the 1.02 is a real number or a modeled one. If their year one revenue assumes concessions burning off on a schedule and the submarket has 900 units still coming, then 1.02 is actually 0.9 and the buydown isn't comfort, it's the only reason the deal closes. Basis is better in the abstract. A deal that trips a covenant in month eight never gets to enjoy its basis.

So I want to see the coverage at trailing three annualized with current concessions, not at the pro forma. If it clears 1.15 without the buydown I'd take the price.

karen_whitfield · Answer

I take the lower price every time and I know that costs me sleep in year two.

My reasoning is boring. I hold long. Anything that expires in three years is irrelevant to me by year six, and the price sits in the basis forever. The thing I'd want in exchange for giving up the rate protection is a bigger operating reserve in the deal, funded at closing, so the suspended distribution is the cost rather than a capital call. That's a negotiation about the reserve line, not the price.

Sponsor wants to buy the rate down instead of taking a lower purchase price

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