A key component of Ackermann Group’s strategy involves the use of Freddie Mac’s supplemental loan program to create cash flow and unlock equity value during the lifecycle of our apartment investments. The supplemental program allows us to take out small, secondary loans against the property that layer in with the original senior mortgage.
For example, a property valued at $40 million takes out a $30 million mortgage at acquisition (a 75% loan-to-value “LTV” ratio). Over the next two years, property improvements and effective management practices drive the value of the property to $44 million. This results in a new LTV of only 68% ($30 million mortgage / $44 million value). Freddie Mac recognizes the increased value created and allows us to take out an additional “supplemental” loan to get back to 75% LTV. In this case, we can borrow an additional $3 million, bringing our total mortgage balance to $33 million (75% of the new $44 million value). The additional cash flow can be reinvested into the property and distributed to investors.
In addition to the LTV metric, the ratio of the property’s cash flow to its debt payments is used to determine its ability to repay the loan (aka “Debt Service Coverage Ratio”). If this metric falls short of Freddie Mac’s requirements, the loan proceeds may be modified as well to bring the ratio into the correct range. This two-pronged test ensures the total debt balance and annual debt service cost are appropriate relative to the specific property’s economics.
This program is attractive for several reasons:
- The ability to capture liquidity from the increased value of the property as it occurs. The time value of money means a dollar received today is immensely more valuable than a dollar received at a future date. Most traditional lenders do not provide a supplemental program, so investors are not able to monetize the increased equity value until a sale or expensive refinance occurs at the end of the investment period. The difference between receiving cash in the early years versus in the final year of an investment can add multiple percentage points to the annualized return.
- These loans are nonrecourse, meaning the investors are not held personally liable for the repayment of the loan. If a default or bankruptcy were to occur, the lender can only access the value of the underlying property. The assets of investors cannot be touched to satisfy the unpaid debt – even your previously received cash from that investment. When we distribute supplemental proceeds, we are effectively taking those dollars off the table from an at-risk perspective for our investors.
- The loans are all fixed interest rate. We are strong believers in using fixed-rate debt. It creates certainty about our future debt payments and removes the risk of market fluctuations that variable-rate borrowers contend with in both good and bad economic times. Variable-rate borrowers have seen drastic swings in their debt service costs amid the post-COVID market turmoil, which in turn creates uncertainty for investors’ cash flow expectations.
- The supplemental program is cheaper and more efficient than executing a refinance of the entire debt. A full refinance can be time-consuming and expensive depending on the terms of a prepayment penalty and other transactional costs. A supplemental loan has much lower transaction costs and can be executed very efficiently with our lending team.
Utilizing the supplemental loan program is a powerful tool in creating additional cash flow and value for our investors. Our investors can expect multiple opportunities for additional cash flow during their investment due to this program. If you are exploring investments in commercial real estate and the multi-family market specifically – please reach out to us to discuss investment opportunities.