Interest rate for a deferred consideration property purcha

[Furbo]

We’re selling some resi properties and a buyer wants to buy them all with 25% of the price deferred for 5 years, interest paid monthly.

They have offered an interest rate but I think it should be a margin OBR.

So for second charge debt of £700k, what margin OBR seems reasonable?

I think we also need a floor.

Any thoughts chaps?

[LooneyTunes]

Furbo said:

what margin OBR seems reasonable?

That depends on their structure, risk rating and your return requirements.

You also need to consider who is doing/paying for the legals - they need to have their head screwed on as there are several considerations that property and financial risk folk would see that say a generalist local lawyer perhaps might not.

[Furbo]

LooneyTunes said:

Furbo said:

what margin OBR seems reasonable?

That depends on their structure, risk rating and your return requirements.

You also need to consider who is doing/paying for the legals - they need to have their head screwed on as there are several considerations that property and financial risk folk would see that say a generalist local lawyer perhaps might not.

Limited co struture.
Yet to credit vet them
I've no fixed ideas regarding return. What is the best savings rate around for £700k currently? 4.5%? I'd want a risk premium. Shooting from the hip, I was thinking 2% OBR. But that is a figure I pulled out of my backside.

[LooneyTunes]

It’s a personal view, and not intended to be unduly critical, but unless you can properly understand your risk exposure there’s a good chance that you will not price this correctly.

Ltds all vary, but one of the fundamentals is that they have limited liability. To understand the risk associated with one needs quite a deep dive into its trading and financials: the risk profile of a “simple” property SPV, exposed to asset price risk and market changes, would be quite different to a broader group with other revenue generative activities and cross-guarantees.

You might get someone pop up and suggest that you can fix many issues with a PG. You can’t. A PG should only ever be the cherry on the top of an already robust arrangement rather than something you actually expect to be able to really rely on. They’re typically of very limited value indeed.

You also might want to consider why they want to defer consideration instead of raising the money elsewhere. If it’s because you’ll offer a lower rate then take that as a clear indication that you’re getting the rate wrong. If they can’t raise it elsewhere, or are trying to make the extent of their liabilities less obvious, you should be wondering why.

[Furbo]

LooneyTunes said:

It s a personal view, and not intended to be unduly critical, but unless you can properly understand your risk exposure there s a good chance that you will not price this correctly.

Yep, very high risk of that. Which is why I am investigating how to price it appropriately. I've considered asking my old bank manager to take a look at it, but whilst I get on well with him it seems a bit cheeky. I don't think our accountants would be suitable.

LooneyTunes said:

all vary, but one of the fundamentals is that they have limited liability. To understand the risk associated with one needs quite a deep dive into its trading and financials: the risk profile of a simple property SPV, exposed to asset price risk and market changes, would be quite different to a broader group with other revenue generative activities and cross-guarantees.

AFAIK it is not part of a group. It's been trading for a while and has other real estate assets but I suspect it is quite well geared.

LooneyTunes said:

might get someone pop up and suggest that you can fix many issues with a PG. You can t. A PG should only ever be the cherry on the top of an already robust arrangement rather than something you actually expect to be able to really rely on. They re typically of very limited value indeed.

With the business owner in question, I think a PG would be useful.

LooneyTunes said:

also might want to consider why they want to defer consideration instead of raising the money elsewhere. If it s because you ll offer a lower rate then take that as a clear indication that you re getting the rate wrong. If they can t raise it elsewhere, or are trying to make the extent of their liabilities less obvious, you should be wondering why.

It is because they don't have enough leverage money to complete the transaction, and won't be able to raise it on the open market.

I would add that there is a good incentive for us to do this, if possible. The assets we are selling are quite specialist and require a buyer with experience and the drive to get the deal put to bed.

[Blue_star]

You are taking on credit risk that you are not qualified to evaluate. I guess if its specialised asset you have part of the picture areasy clear.

Based on their financial statements can you figure out what their current interest rate is?

[Furbo]

Blue_star said:

You are taking on credit risk that you are not qualified to evaluate. I guess if its specialised asset you have part of the picture areasy clear.

Based on their financial statements can you figure out what their current interest rate is?

I am fully aware that I am not qualified to evaluate it. Which is why I started this thread. Given that those who are qualified don't always price correctly, there will inevitably be an element of guesswork.

I have a good idea what they are paying for senior debt, but that has no bearing upon this. It is subordinate debt, second charge, and I doubt they have anything like it currently.

[LooneyTunes]

Furbo said:

LooneyTunes said:

also might want to consider why they want to defer consideration instead of raising the money elsewhere. If it s because you ll offer a lower rate then take that as a clear indication that you re getting the rate wrong. If they can t raise it elsewhere, or are trying to make the extent of their liabilities less obvious, you should be wondering why.

It is because they don't have enough leverage money to complete the transaction, and won't be able to raise it on the open market.

That alone should tell you that base + 200bps is probably nowhere near the correct rate. Nobody will be able to correctly price it, using a risk based approach, without looking deeply into the specifics of the company. Pricing using commercial comparators would overlook the significance of single deal vs a portfolio: all or nothing is a different proposition to potentially having a % of non-performing loans within a much larger pool.

Put pricing aside, who is going to draft the documentation for you and sort registration of charges etc? If they re leveraged up already, presumably they ve told you there are no negative pledge clauses that could complicate matters? Getting the documentation right is important but properly knowledgeable lawyers in that really know how to charge

Ultimately it depends on what that £700k means to you but, if it d be important not to lose it, you really want a proper corporate debt person looking at the fine details. Do not forget that £700k with I/O prior to a single maturity event presents someone flaky with tremendous opportunity, especially if you don t have ongoing monitoring in place.

There are specialist properly lenders out there. Personally I think you d be better off steering the purchaser towards those and getting paid on the nail.

[hajaba123]

I’d say that’s equity risk you’re taking if I’ve read it right. A few percent interest wouldn’t be anywhere near an appropriate return. There is a lot going on here though and it seems like a deal you’re very keen to execute

[Furbo]

LooneyTunes said:

That alone should tell you that base + 200bps is probably nowhere near the correct rate. Nobody will be able to correctly price it, using a risk based approach, without looking deeply into the specifics of the company. Pricing using commercial comparators would overlook the significance of single deal vs a portfolio: all or nothing is a different proposition to potentially having a % of non-performing loans within a much larger pool.

I hear you. As you say, it would be a very difficult thing to price and given the consideration I don't think we can afford to pay someone to have a really good guess.

LooneyTunes said:

pricing aside, who is going to draft the documentation for you and sort registration of charges etc? If they re leveraged up already, presumably they ve told you there are no negative pledge clauses that could complicate matters? Getting the documentation right is important but properly knowledgeable lawyers in that really know how to charge

We've a commercial solicitor. Fees to be paid by the buyer.

LooneyTunes said:

it depends on what that £700k means to you but, if it d be important not to lose it, you really want a proper corporate debt person looking at the fine details. Do not forget that £700k with I/O prior to a single maturity event presents someone flaky with tremendous opportunity, especially if you don t have ongoing monitoring in place.

Well, £700k is a lot of money and I would be disappointed to lose it. Monitoring - what could we do? Receive quarterly management accounts?

LooneyTunes said:

are specialist properly lenders out there. Personally I think you d be better off steering the purchaser towards those and getting paid on the nail.

The deal would not happen. Which is of course a driver for a greater premium.

An aside - we have also considered extending to them a private mortgage. We would then be the senior creditors.

[Furbo]

hajaba123 said:

I d say that s equity risk you re taking if I ve read it right. A few percent interest wouldn t be anywhere near an appropriate return. There is a lot going on here though and it seems like a deal you re very keen to execute

Hmmm not equity risk in the sense that I understand it. Vendor financing / deferred consideration.

[rhlshrm2430]

If it were me, I’d price it like mezz debt, not a favour - decent margin over base and a floor baked in. Five years is a long time if things go sideways.

[Furbo]

rhlshrm2430 said:

If it were me, I d price it like mezz debt, not a favour - decent margin over base and a floor baked in. Five years is a long time if things go sideways.

Yep, we've already said a floor will be there.

[Panamax]

LooneyTunes said:

Personally I think you'd be better off steering the purchaser towards those and getting paid on the nail.

Absolutely this. And if "the deal wouldn't happen" it's probably a deal to steer clear from in any event.

If it's several properties, why not just keep £700k of them and grant the buyer a lease together with a "put" option that you can exercise after 5 years?

[Blue_star]

Furbo said:

Blue_star said:

You are taking on credit risk that you are not qualified to evaluate. I guess if its specialised asset you have part of the picture areasy clear.

Based on their financial statements can you figure out what their current interest rate is?

I am fully aware that I am not qualified to evaluate it. Which is why I started this thread. Given that those who are qualified don't always price correctly, there will inevitably be an element of guesswork.

I have a good idea what they are paying for senior debt, but that has no bearing upon this. It is subordinate debt, second charge, and I doubt they have anything like it currently.

This is pretty good start point though right. In a way you have delegated the calculation of risk premium. So you know what they pay for senior debt as % so this is one figure to take into account.

You know your current return on property so second figure to take into account. Minimum of current return on property @25%

You say no bearing so i am probably going to say something stupid but isn't your arrangement secured one on properties so you get back if they dont pay?
Also I assume you have opportunity to invest the cash you receive from property so wont you make enough return on investment to recover any potential interest lost if they dint pay?

Edited by Blue_star on Saturday 24th January 14:55

Edited by Blue_star on Saturday 24th January 15:01

[Furbo]

Panamax said:

LooneyTunes said:

Personally I think you'd be better off steering the purchaser towards those and getting paid on the nail.

Absolutely this. And if "the deal wouldn't happen" it's probably a deal to steer clear from in any event.

If it's several properties, why not just keep £700k of them and grant the buyer a lease together with a "put" option that you can exercise after 5 years?

I understand your viewpoint.

What I would say is that in the past I’ve done very well out of risky stuff. Or at least finding ways of doing deals and getting around things that others have been unable to.

There are other structures that I could use but they want to buy everything as a connected transaction. I suspect the SDLT treatment is better.

I’ve sold properties to this buyer before and they have performed. Albeit they were conventional transactions. I’ve had a lot of time and money wasted by buyers who have not.

The price I am being offered is also good.

So good buyer, good price, I am going to try to structure something if I can.

[Furbo]

Blue_star said:

Furbo said:

Blue_star said:

You are taking on credit risk that you are not qualified to evaluate. I guess if its specialised asset you have part of the picture areasy clear.

Based on their financial statements can you figure out what their current interest rate is?

I am fully aware that I am not qualified to evaluate it. Which is why I started this thread. Given that those who are qualified don't always price correctly, there will inevitably be an element of guesswork.

I have a good idea what they are paying for senior debt, but that has no bearing upon this. It is subordinate debt, second charge, and I doubt they have anything like it currently.

This is pretty good start point though right. In a way you have delegated the calculation of risk premium. So you know what they pay for senior debt as % so this is one figure to take into account.

You know your current return on property so second figure to take into account. Minimum of current return on property @25%

You say no bearing so i am probably going to say something stupid but isn't your arrangement secured one on properties so you get back if they dont pay?
Also I assume you have opportunity to invest the cash you receive from property so wont you make enough return on investment to recover any potential interest lost if they dint pay?

Edited by Blue_star on Saturday 24th January 14:55

Edited by Blue_star on Saturday 24th January 15:01

It would be secured on all the properties and I would have a personal guarantee from the director. One of the problems they will face is, I suspect, whether their term lender will mind a second charge.

[LooneyTunes]

Furbo said:

It would be secured on all the properties and I would have a personal guarantee from the director. One of the problems they will face is, I suspect, whether their term lender will mind a second charge.

By all means try to get the PG, but don’t expect it to be worth much/anything. Regarding the second charge, that’s why you need to look for negative pledge provisions etc.

Blue_star said:

You say no bearing so i am probably going to say something stupid but isn't your arrangement secured one on properties so you get back if they dont pay?

He’d be taking a subordinated position in the debt structure. That is not always a good place to be… especially on an asset that is more specialised. A rapid sale may yield enough to repay the primary debt but possibly not the subordinated. Might be different if there were ways to over-collateralise within the transaction but OP appears to be focussed only on the assets he’s selling as being available for security.

[Furbo]

LooneyTunes said:

Furbo said:

It would be secured on all the properties and I would have a personal guarantee from the director. One of the problems they will face is, I suspect, whether their term lender will mind a second charge.

By all means try to get the PG, but don t expect it to be worth much/anything. Regarding the second charge, that s why you need to look for negative pledge provisions etc.

Blue_star said:

You say no bearing so i am probably going to say something stupid but isn't your arrangement secured one on properties so you get back if they dont pay?

He d be taking a subordinated position in the debt structure. That is not always a good place to be especially on an asset that is more specialised. A rapid sale may yield enough to repay the primary debt but possibly not the subordinated. Might be different if there were ways to over-collateralise within the transaction but OP appears to be focussed only on the assets he s selling as being available for security.

The other assets in the business were 50% sold to it by me and I know at what level they are geared. I could possibly take a second charge, but, as you say, that can be precarious in the event of a distressed sale.

[hajaba123]

LooneyTunes said:

He d be taking a subordinated position in the debt structure. That is not always a good place to be especially on an asset that is more specialised. A rapid sale may yield enough to repay the primary debt but possibly not the subordinated. Might be different if there were ways to over-collateralise within the transaction but OP appears to be focussed only on the assets he s selling as being available for security.

That's my point about equity risk (or not) He's looking to defer the 25% top slice of the deal on interest only over 5 years, purchaser is borrowing the rest (?). So to me that's covering the equity in the transaction. Yes second charge is available but it wont cover the full risk- property value doesn't;t rise/ decreases, cashflows disappear all of a sudden the 25% diminishes/ disappears. Guess can be mitigated by regular valuations/ understanding the cashflows and additional security.
Just feels much much racier than a couple of percent turn to do it