Making Assumptions in CRE

I’ll make the assumption you want to read about this today – Loan Assumptions!

You may see that loan assumptions are becoming more mainstream in today’s market.

Here’s exactly what a loan assumption is and how to input this correctly in your underwriting model.

Loan Assumptions Simply Defined:

With a loan assumption, the new borrower can quite literally assume or take over the existing loan terms already on the project. Many types of loans are assumable, including most Fannie Mae, Freddie Mac, HUD multifamily, and CMBS loans.

With most long term debt products, the seller may only be willing to sell the project if the new buyer assumes their loan. This is mostly due to the current loan having some form of yield maintenance or prepayment penalty due. I’ll talk more about these in a future issue, but it’s just a fee the seller would be required to pay in order to compensate the financial institution for paying off the loan early. Because the new buyer will take over the loan (and agree to continue paying), there is no prepayment penalty if the loan is assumed.

Assuming the loan to buy the project is never required, however, usually the prepayment penalty is so significant, it only makes financial sense to assume the loan.

What Information You Need:

A broker sends you a deal and mentions “the loan is assumable.” Here’s what you need to know about the current loan in order to model this correctly:

  • Original Note Amount
  • Current Loan Balance
  • Date of Original Note
  • Maturity Date
  • Interest Rate
  • Amortization Years
  • Interest Only Years

Pro Tip: Sometimes, the same document that specifies the terms of the original note will also show the debt service payment. After you input the loan terms (explained in next section), verify the debt service payment in your underwriting model matches the debt service payment you see from that document.

Underwriting a Loan Assumption:

Since every underwriting model is different, I will go over the basics of what you should do in your model:

  1. First, adjust your model so that the loan balance reflects the current loan balance of the original note. You may have to manually adjust your LTV or some models allow you to input an exact loan balance for this purpose.
  2. Second, verify how many years of interest only are remaining on the original loan. For example, if the original loan was originated on 1/1/2020 with 3 years of interest only payments, you would input 0 years of IO if you were to assume the loan on 1/1/23.
  3. Third, input your interest rate to reflect that of the original note. This will most likely be at a fixed interest rate.

Again, every underwriting model is uniquely different. But it comes down to manipulating your model to reflect the loan terms of the note you are assuming at the closing date.

Basically, if the original loan was for 120 months (10 years) and you assume the loan on their month 36 – Your month 1 will have the loan terms reflected from their month 36.

Underwriting Example:

A broker sends me a deal that has an assumable Fannie Mae loan with some basic terms outlined on the left.

I can see the loan was originated on 1/1/2020 and let’s hypothetically say I’ll close this deal on 1/1/23.

So in my underwriting model (right picture), I manipulate my inputs to reflect these terms for our acquisition date. Based on the purchase price I offered and the current loan balance, I will have an LTV of 55%.

The original loan did not have any interest only, and therefore, has amortized for 3 years.

I input the 5% fixed interest rate and then verify my underwriting model is calculating the correct debt service amount I see from the original loan statement.

Check out the Next Level Value Add Model where you can easily model loan assumptions and supplemental loan options.