The Advantages Of Loan Assumption In A High-Interest Rate Market
Interest rates have risen exponentially in the past year when compared to early 2022, and this has affected the type of strategies used to acquire properties. When the Federal Reserve first started raising interest rates back in March 2022, many single-family residential investors kept purchasing properties as usual to either "buy and hold" or "fix and flip," and commercial real estate or multifamily investors were still purchasing apartment buildings with floating or variable debt.
But then, as the Federal Reserve raised interest rates month after month without pausing, I noticed a shift among other multifamily or single-family investors who were no longer buying as many properties. I also saw an increase in accredited investors who were beginning to sit on their money instead of investing in the opportunities presented to them.
Fast forward to today with interest rates five percentage points higher at the time of this writing, and I've noticed a rise in the prevalence of loan assumptions within the multifamily sector.
What Is A Loan Assumption?
Loan assumption refers to the process whereby a buyer takes over the existing debt of a property from a seller. However, the loan assumption is subject to the buyer's qualification with the lender. This means not everyone can take advantage of this option.
Suppose the price of the property exceeds the existing debt on the property. In that case, the buyer is responsible for bringing the difference to the closing table by raising capital (equity) or getting a second loan to fill the gap and close the property.
An example of this would be a seller having $10 million in debt at a 3.5% interest rate left on a property, but they intend to sell that property for $15 million. The buyer would need to come up with the remaining $5 million in equity or a second loan by closing to acquire this asset at that current interest rate.
In high-interest rate times like these, taking a second loan to acquire the property would not be favorable for the investor purchasing it, which is why they would seek equity to acquire this asset.
Advantages Of A Loan Assumption
• If the interest rate is lower than current market rates, it instantly saves the investor money.
• Fewer closing costs.
• It benefits the seller by saving them more money and potentially getting an offer closer to the fair market value for the property due to the favorable interest rate.
Ways To Take Advantage
Even though these types of loan assumption opportunities are available, not many investors can take advantage of them because they lack the experience or the resources to do so. This is where a strong network can be beneficial.
You start finding a network online through places like Facebook and Linkedin. Facebook is especially great when you're using the groups they have on there. They have a lot of real estate groups you can join in order to start networking. If you're a new syndicator, you want to find a key principal or "KP" to help assist you in obtaining funding or assuming the debt on a property. They're important because they typically have the net worth and experience to help you acquire the asset and will do so in exchange for part of the general partnership or "GP."
Another option is to join a mentorship program. The people leading the mentorship program should have experience, a portfolio and a net worth to help you acquire an apartment building as a new syndicator. This option is typically more expensive up front, but it eliminates your chances of running into people who will waste your time.
I see more experienced investors moving in the loan assumption direction as the interest rates remain high relative to the past few years. This scenario tends to benefit all parties involved. This is especially true in commercial real estate since operators are often looking to sell a property after five to seven years versus sitting on it for longer. This gives the operator time to bring as much value to the property as possible. It also gives the market time to correct itself and make rates more favorable before a refinance is needed or the operator chooses to exit the property.
I believe this economic climate is helping create an opportunity for more passive investors or limited partners (LPs) to take advantage of lower interest rates by investing with experienced operators who are using this loan assumption strategy to acquire apartment buildings currently.