The Opportunity Provided by Time
Loan: $40,500,000
Client: Real Estate Developer
Location: Midwest
Budget: 6.75%
Project: Commercial office
Benefit to Borrower: $400,000 in 1 year
Borrower Situation
It’s late 2000 and we're retained to manage the interest rate risk on a to-be-built office building. We’re excited, our client borrower is excited, and so is the institutional equity partner, who would like rate protection. The budget is 6.75% LIBOR, and the institutional equity partner wants a cap in place for the first loan draw. Easy! The cap is purchased, set to end in March 2003. The construction loan is $40.5MM and there is substantial equity to the tune of $17MM. All of the LIBOR options from the construction lender are available, from one-month to one-year.
Well, build it and they don’t always show up. Almost three years later, the 365,000SF office building is complete, but only 20% leased. This is when construction lenders are sometimes hard to live with. During '01, ‘02 '& ‘03, interest rates did nothing but fall. LIBOR during that period of time fell from approximately 6.77% to 1.30%. That’s quite good for carry costs but 20% occupancy doesn’t make it.
A little more equity is required…thank goodness it is an institutional equity investor. The construction lender is happy with additional funds, and provides a three-year loan extension. They also insist on a 2% LIBOR floor. Rats! LIBOR is still 1.30%. The same institutional partner who wanted rate protection when LIBOR was more than 5% higher no longer wants rate protection. With one-month LIBOR being 1.30% and at that time, one-year LIBOR being 1.34%, there was nothing to do.
CIRM Solution
However, given the 2% LIBOR floor, there was something very important to do. Since the floor implied there was no benefit from fixing long, it was critical to monitor the interest rate markets so that when one-year LIBOR got to 2%, regardless of what one-month LIBOR was, this was the time to fix the loan. That occurred in May 2004. The entire loan was then fixed for one-year. Of course, this occurred during the "measured" period of Alan Greenspan's tightening binge and during the next year, rates rose substantially, averaging slightly more than 3% LIBOR.
Result
Just by monitoring the market, The CIRM saved the client 100 basis points — over $400,000 — on the outstanding loan balance for one year. It was never envisioned that the loan would have to be extended and modified, but The CIRM's ability to be flexible and interpret changing situations saved our client multiples of our retainer fee with one decision that was not anticipated to be required when we were engaged. The CIRM's ability to understand changing circumstances and loan situations is unparalleled.
In 2005, the project finally leased up and sold. It could have been a better real estate story (real estate markets do change), but it certainly could also have been a much worse finance story (interest rates change)!
