Definition
Mortgage Out: Mortgage Out refers to a financing strategy where developers obtain a loan that exceeds the cost to develop a project. This practice was more prevalent during easy-money periods when developers could secure a permanent loan commitment based on a high percentage of the project’s completed value. This allowed them to borrow more than the cost required to construct the project. This financing strategy has become nearly obsolete due to stricter financial constraints, such as lower loan-to-value ratios, higher capitalization rates, and increased construction costs.
Examples
Example 1
A developer plans a commercial office building that is projected to generate an annual net operating income (NOI) of $100,000. With a capitalization rate of 10%, the building’s value is estimated at $1,000,000. The developer secures a takeout loan commitment for 80% of this value, amounting to $800,000. However, the total cost to purchase the land and construct the building is only $750,000. The remaining $50,000 from the loan represents the excess cash available to the developer due to the mortgage out scenario.
Example 2
Consider a residential apartment complex with an estimated completed project value of $2,000,000 and an annual NOI of $160,000, assuming an 8% capitalization rate. If a developer obtains a loan commitment for 75% of the completed project’s value, amounting to $1,500,000, but the construction costs only total $1,200,000, the extra $300,000 represents the developer’s excess cash resulting from mortgaging out.
Frequently Asked Questions
What is a Mortgage Out?
A mortgage out is when a developer secures financing that exceeds the project’s construction costs, typically achieved during times when easy credit is available.
Why is Mortgaging Out Less Common Nowadays?
Mortgaging out has become less common due to lower loan-to-value ratios, higher capitalization rates, and increased construction costs, making it more challenging for developers to secure loans that exceed construction costs.
What is a Takeout Loan in the Context of Mortgaging Out?
A takeout loan refers to a type of financing commitment that replaces the initial construction loan with a long-term loan upon project completion. This is the mechanism that allows mortgaging out by enabling developers to refinance at a higher value once the project is completed.
How Does a Higher Capitalization Rate Affect Mortgaging Out?
Higher capitalization rates reduce the estimated value of a completed project relative to its net operating income, thus lowering the potential loan amount a developer can secure, thereby making mortgaging out more difficult.
Related Terms with Definitions
Loan-to-Value (LTV) Ratio
The loan-to-value ratio is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. It is crucial in determining the borrowing risk level.
Capitalization Rate
The capitalization rate, or cap rate, is a real estate valuation measure used to compare different real estate investments. It is calculated by dividing the net operating income by the current market value of the property.
Takeout Loan
A takeout loan provides long-term financing to replace a short-term construction loan. It stabilizes the financing by offering longer repayment terms.
Net Operating Income (NOI)
Net operating income is a calculation used to analyze the profitability of income-generating real estate investments. It is the total income generated from the property minus the operating expenses.
Permanent Loan
A permanent loan is a long-term mortgage that is typically used to finance income-producing property after the construction phase is complete.
Online Resources
References
- Real Estate Finance and Investments, William Brueggeman and Jeffrey Fisher
- Commercial Real Estate Analysis and Investments, David M. Geltner and Norman G. Miller
Suggested Books for Further Studies
- “The Real Estate Wholesaling Bible” by Than Merrill
- “Investing in Apartment Buildings” by Matthew A. Martinez
- “Real Estate Finance & Investments” by William Brueggeman and Jeffrey Fisher
