Conduits vs. Portfolios - When you run the numbers, interest rate isn't always king. 
 
Long-term flexibility might make portfolio loans a better option for many borrowers.

Conduit - Insurance - Pension Fund loans are terrific. They offer the best-possible interest rate locked in for the long term, which can boost your bottom line. So if you qualify for a conduit - insurance - pension fund loan, why would you consider anything else? Because conduit - insurance - pension fund loans are inflexible.

Portfolio loans, on the other hand, usually allow you to adapt to changes in the economy, to the property or to your own situation. Although portfolio and conduit loans each have pros and cons, in the long run, getting the right loan for your needs sometimes goes beyond getting the lowest rate.

As a Direct Commercial Mortgage Bank offering Direct Portfolio and Institutional Conduit, Insurance and Pension Fund commercial loans, shialink.org saves you time and money by creating a competitive environment that forces the market to compete for your business.

Making comparisons

Conduit loans offer the best interest rates on commercial loans. We book the loan, put it together, package it and sell it to a third party, such as one of our insurance companies or pension funds. Generally speaking, conduit loans:

• Provide a guaranteed return of investment for our investors (backed by interest-yield-maintenance prepayment-penalty clauses or defeasance fees);
• Provide a fixed-rate, long-term loan for borrowers;
• Lock up the borrower's equity by disallowing second or third loans on the same property; and
• Do not allow changes to the loan terms.
• Portfolio lenders, however, offer conventional loans that we hold and work into our own portfolios. We have a vested interest in the property's success, and will likely want to work with borrowers to maintain or enhance the property's value.

Generally speaking, portfolio loans:

• Afford flexibility when a deal or property involves moving parts;
• Allow borrowers to forge a relationship with the decisionmaker handling the portfolio; and
• Usually have fixed-rate structures, such as fully amortizing loans, with no calls or balloons tied to a long-term, historically, stable index.

When flexibility trumps low rates

The interest rate is not always the most important factor in the loan decision. Conduit loans are ideal for borrowers purchasing a fully developed property with locked-up leases. You can lock in your rates and terms upfront and then ride out the loan. We put the loan on a shelf, and the borrowers make the payments. Everyone is happy.

But what if the deal or the property has moving parts? What if the property is not fully developed and you want to explore those possibilities?

Take Chris, for example. He is in escrow on a medium-sized strip mall on a busy, suburban street. His initial inclination was to get a locked-up loan with the best interest rate. Then he learned that the property had excess parking, and he began to reconsider his loan options.

Chris wants to carve out a piece of the parking lot and put in a coffeehouse. The extra traffic would bring more business to all the tenants, and the addition would increase the property's overall value.

To make this property improvement happen, however, Chris needs a lender that will work with his changing needs. In this situation, the lender must approve the carve-out and lot-line adjustment, partially reconvey the carved-out piece of property and either fund the construction loan or allow Chris to get the loan from a third party.

With a conduit loan, these types of changes would probably cause a prepayment penalty. The costs of these penalties, coupled with the costs of starting over, could easily kill the deal's financial feasibility. Not so with a portfolio loan. Chris realizes that in this circumstance, the rate is just one part of the loan-decision picture.

Consider another example. A borrower is coming out of a 1031 exchange and has bought an office building. Now the market is changing, and the company realizes the building has increased in value. The question is if the current lender will allow the company to convert the properties increased equity position into additional cash for upgrades or the purchase of new properties. 

If the loan on the property is a conduit loan, the answer is "probably not." Conduit loans are sold to third parties looking for clean and perfect deals; they are meant for situations in which no changes are needed or planned for the property.

Even some portfolio lenders may balk at such a deal. Only the most-flexible ones would be likely to take it. Having a flexible lender with the experience and expertise to help build value in the property is key.

If you can foresee a time when you will want to take equity out of your property to fund the purchase of another property or when they'll want to fund future tenant improvements, your best bet is to go with a portfolio lender. Such lenders have the flexibility and stability to work with you to make changes to your property and your loan.

The cost of the wrong loan

It is important to get the right type of loan for your needs upfront because the cost of having the wrong loan can be high. If you choose a portfolio loan when a conduit loan would meet your needs, the higher interest rate will increase costs and decrease cash flow and profits during the life of the loan. On a large transaction, these costs can add up.

On the other hand, if you have a conduit loan in place when you want to take out equity or make changes to a property, the conduit lender likely will be unwilling to work with them.  Therefore you will either incur the costs of starting over -- including the conduit prepayment penalty and the costs of the new loan (fees for escrow, title, appraisal and documentation, possibly additional points) -- or you'll suffer the opportunity cost of the lost deal (tenants lost, value-enhancing property improvements not made, etc.).

Consider the following example. Bob owns a multitenant industrial building in the city center. After one of his major tenants goes out of business, another tenant -- a successful manufacturing company -- has expressed a desire to expand into the now-vacant space. That is, if Bob will pay for the necessary space improvements.

Bob's conduit lender not only was unwilling to fund the improvement loan but also did not allow him to get the loan elsewhere. His only option was to pay the stiff interest-yield-maintenance prepayment penalty and start over with another lender.

The costs of doing this, however, killed the deal. The manufacturer had to move out of Bob's building to a more accommodating property. Thanks to this domino effect, instead of having a happy tenant occupying two spaces, Bob now owns a half-empty building.

Borrowers' needs and options

So which type of loan is best for you? The answer depends on your long-term needs. In the short term, the interest rate usually is the most important factor. In the long term, however, the interest rate may be trumped by the need for a flexible direct lender, such as shialink.org, that will work with you as the economy and your situations change.

Run the numbers and ask:

• Is the property fully developed -- does it have upside potential?
• What is the tenant situation?
• Does the lender have the capital to fund any future tenant improvements?
• What are the shortand long-term goals for the property?
• What are your goals for the overall commercial real estate portfolio?
• As you build equity, will you want to take some of it out?
• How will changes in the economy affect your goals for the property?
• If you determine that a portfolio loan will best suit your needs, bear in mind that not all portfolio lenders are created equal.

Look for a lender with:

• Expertise in commercial real estate transactions;
• Flexibility to help create more value in the property;
• Accessible decisionmakers who will work directly with you;
• Stability in management so that you will be talking to the same people five years after you negotiated the deal;
• Consistency in policies and business philosophy so that there are no surprises later; and
• Strength in capital so that the Direct Lender can meet your needs.

Having a stable and flexible Direct Lender with the financial strength to create portfolio loans can provide great short and long-term flexibility. If there are any moving parts to the deal -- or if any develop down the road -- the right portfolio lender will be able to work with your needs.

When you run the numbers, interest rate isn't always king.