SS274: How Long-Term Debt Protects Your Returns

SS274: How Long-Term Debt Protects Your Returns

Long-term debt is one of the most powerful tools multifamily investors can use to reduce risk. In this episode, Charles discusses the benefits of long-term fixed debt and how it can help stabilize your property.

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Talking Points:

  • While many real estate investors mainly focus on interest rates alone when getting a mortgage, the structure of the debt can matter just as much, sometimes even more.
  • Long-term debt lengthens your property’s runway; the longer it is, the lower the investor’s risk exposure usually is. This happens for a few reasons.
    • 1. Interest Rate Protection. Interest rate volatility is one of the greatest risks real estate investors, especially commercial real estate investors, will face. Many investors take out short-term loans, such as bridge or hard money loans, to close on a property quickly with lower down payments, which puts the investor in a position to reposition the property quickly and, hopefully, resell or refinance it once the value has increased. The problem is, a 1–3-year loan is not much time to weather renovation delays or wait out an economic pullback, and if interest rates have increased, the whole deal may go south, as so many did in 2022 and 2023. Having long-term debt, usually with a higher interest rate and a higher down payment requirement, gives investors ample time to complete their business plan without having to make renovations that might not be practical during a down market.
    • 2. Principal Pay Down. Many short-term real estate loans are interest-only, while most long-term loans feature interest and principal paydown. As you pay your mortgage, your equity increases, your net worth increases, and your loan-to-value decreases. The lower your leverage, the lower the investor’s risk exposure in a property is. This allows for more flexibility. And if you need a chunk of cash in the future, simply refinance the property or add a second mortgage, since one thing that all lenders like is a property with a lot of equity to lend against.
    • 3. Inflation Hedging. As you pay down your mortgage, you are paying the bank back with dollars that are cheaper than when you borrowed. So, as inflation increases and your property value increases, your loan-to-value decreases. This puts the owner in a safer position every time they make a mortgage payment, and with every payment, they are paying the bank with cheaper dollars. The real benefit of fixed long-term debt is that if you own a property and inflation spikes, inflation is pretty much eroding your debt.
    • 4. Avoids Required Refinancing or Sale. You never want to be forced to sell or refinance a property. Long-term fixed-rate debt gives the investor a long runway in which, 7, 10, 12, or more years down the road, the net operating income and property value will grow and offset any market headwinds when they refinance. The investor also avoids expensive financing hassles and fees that can add up quickly.
    • 5. Consistency. With fixed, long-term debt, the monthly interest and principal payments remain fixed for the life of the loan, providing stability for the investor. There is no need to worry about current interest rate fluctuations or, worse, having to predict where interest rates will be in 2 years. Consistency is one thing that passive investors look for in a deal, and offering that will make your project more attractive.
  • Long-term fixed rate debt isn’t about maximizing returns – it’s about protecting returns. If you purchase a property that cashflows, with long-term debt while having ample reserves, it makes it really hard to lose money. If you want to learn how to reduce your real estate debt with inflation, check out episode SS47.

Transcript:

Charles:
Welcome to Strategy Saturday! I’m Charles Carillo, and today we’re breaking down how long-term debt protects your returns. Most investors focus on just interest rates. But the structure of your debt can matter just as much, so let’s get started. While many real estate investors mainly focus on interest rates alone when getting a mortgage, the structure of your debt can matter just as much, and sometimes even more. Long-term debt lengthens your property’s runway, and the longer it is, the lower the investor’s risk exposure usually is. And this happens for a few reasons. Number one is the interest rate protection. So interest rate volatility is one of the greatest risks real estate investors, especially commercial real estate investors will face. Many investors take out short-term loans, such as a bridge or hard money loans to close on a property quickly with lower down payments, which puts the investor in a position to reposition the property quickly and hopefully resell or refinance it once the value has increased.

Charles:
Now, the problem is, is that a one to three year loan is not much time to weather renovation delays or wait out an economic pullback. And if interest rates have increased, the whole deal may go south as it did in 2022 and 2023 for so many deals. Now, having long-term debt, usually with a higher interest rate and a higher down payment requirement, gives investors ample time to complete their business plan without having to make renovations that might not be practical during a down market. Number two is principle pay down. So many short-term real estate loans are interest only. While most long-term loans feature interest in principle pay down. So as you pay your mortgage, your equity increases, your net worth increases and your loan to value decreases. The lower your leverage, the lower the investor’s risk exposure is in a property. Now this allows for more flexibility and if you need a chunk of cash in the future, simply refinance the property or add a second mortgage since one thing that all lenders like is a property with a lot of equity to lend against.

Charles:
Number three is an inflation hedging. So as you pay down your mortgage, you are paying the bank back with dollars that are cheaper than when you borrowed. So as inflation increases and as your property value increases, your loan to value decreases. This puts the owner in a safer position every time they make a mortgage payment and with every payment, they’re paying the bank with cheaper dollars. The real benefit of fixed long-term debt is that if you own a property and inflation spikes, inflation is pretty much eroding your debt. Number four is avoids required refinancing or sale. So you never wanna be forced to sell or refinance a property long-term. A fixed rate debt gives the investor a long runway in which 7, 10, 12, or more years down the road, the net operating income in property value will grow and offset any market headwinds when they refinance.

Charles:
And the investor also avoids expensive refinancing hassles and fees that can add up quickly. Number five, it’s consistency. With fixed long-term debt, the monthly interest and principal payments remain fixed for the life of a loan, providing stability for the investor. There is no need to worry about current interest rate fluctuations or worse, having to predict where interest rates will be in two years. Consistency is one thing that passive investors look for in a deal and offering that will make your project more attractive. Long-term fixed rate debt isn’t about maximizing returns, it’s about protecting returns. If you purchase a property that cash flows with long-term debt while having ample reserves, it makes it really hard to lose money. And if you wanna learn how to reduce your real estate debt with inflation, you can check out episode SS 47. That’s SS 47, so I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics at globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs at syndicationsuperstars.com. That is syndicationsuperstars.com. Look forward to two more episodes next week. See you then.

 

Links Mentioned In The Episode:

  • SS47: How To Reduce Your Real Estate Debt With Inflation

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