Buying down the rate versus taking a lower purchase price on the same check

Question

Consider a 240 unit deck where the sponsor pays about 2.1 points into a rate buydown and an interest rate cap that runs three years. The alternative on the table 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 the deal 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 can look like buying comfort. If the exit is on a cap rate, 1.8M off the price is straight equity. If a refinance is needed in year three anyway, the cap expiring lands the deal in the same place with a worse number on the recorded price. A construction background trains someone to grab the permanent thing ahead of the temporary thing, but plenty of deals die in month fourteen of a lease-up, which is a reminder that surviving is not free either. Confirm any cap or buydown pricing in writing with the lender, since it moves. Which way would the room take it.

aaron_fitz10 · Answer

The part that decides it is whether the 1.02 is a real number or a modeled one. If year one revenue assumes concessions burning off on a schedule while the submarket still has 900 units coming, then 1.02 is closer to 0.9, and the buydown stops being comfort and becomes 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 the number to see is coverage at trailing three annualized with current concessions rather than at the pro forma. If it clears 1.15 without the buydown, 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.

Buying down the rate versus taking a lower purchase price on the same check

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