Pent Up Equity with Existing Debt

Here is an interesting position that I have been seeing pop up recently.

With capital markets being a bit erratic, sizing new senior debt has been tougher. The volatility in interest rates has created a moving target for loan proceeds and is negatively affecting refinances and acquisitions.

Interestingly, deals with existing long-term debt are a bit immune to this issue because the uncertainty of loan structure is absent.

When borrowers are looking to tap into equity, paying off the existing senior is typically not the best path. This is primarily because the debt, which is assumed to be fixed rate, has a high prepay requirement or has intrinsic value due to its low interest rate.

Assuming national Value and NOI Indexes from AIMI, a property with a loan originated in 2019 has grown in value even after a reset. More importantly, cash flow has significantly risen to increase the cushion to service the debt. The value and cash flow provide the ability to supplement the capital stack. With a combination of the Market Gain and amortization of the debt, preferred equity takes original common equity off the table without a refinance or a sale.

This won’t be the case for all deals, but it is worth a look. The concept can apply to other situations, but the bottom line is that there are capitalization options when attractive existing debt is in place.

I could imagine seeing more of this through 2025.