Since launching Portfolio Debt Manager (PDM) in the last few months, we here at Piracle have been anxious to hear back from businesses utilizing the software. We’re proud to share some early feedback.

“Before PDM, I had to manually key all my entries into spreadsheets and keyed them into Timberline,” said Brad Margetts, Vice President of Finance for Gardner Company. “Now, I only have to verify the interest calculation on my bank statements with the calculation being tracked in PDM. And with the integration back into my accounting software I can make and post the payments to the correct GL.”

PDM is a complete loan management system for a borrower that automates loan transactions for real estate loans, construction loans, development loans, permanent loans, lines of credit, equipment, and inter-company loans. The system retains pertinent data regarding your loan’s origination and maturity dates, payment attributes, payment changes, interest attributes, interest changes, commitment amounts and also has the ability to electronically store loan documents, promissory notes, and statements, etc. The system manages both fixed and variable interest rate loans, with indexes such as LIBOR and Prime, updated daily. This gives you accurate, instant, up to date loan information at your fingertips anytime, anywhere with robust portfolio management to help you manage your real estate investment portfolio as it relates to your debt.

To learn more about PDM or to contact us, stop by our site.

A Debt Service Coverage Ratio (DSCR) is a measure of risk often used by real estate lenders to assess the risk of a particular loan or portfolio of loans.  A DSCR measures the ability of a real estate asset to cover its debt service requirement.  The calculation is made by dividing the Net Operating Income (NOI) by the amount of the debt service.  NOI is defined as the income generated from a real estate asset minus the operating expenses necessary to operate the asset, but before the deduction for debt service, depreciation, and taxes.  Debt service is defined as the periodic payment to service the debt.  If an annual NOI is to be used in the calculation, match the debt service by using the annual amount.  Let’s take a look at the calculation (where n is the number of loans secured by the asset or portfolio):

For the asset or portfolio, all the values for NOI are summed up and divided by the summation of all the debt service values.

Let’s walk through an example with the following assumptions:

A DSCR of 1.19 tells us that the asset’s debt service is being covered with enough income left over to cover an additional 19% of debt service.   Notice that the monthly payment of Loan 1 was multiplied by 12 to arrive at an annual amount.  The $23,250 of debt service for Loan 2 is already an annual amount.  The NOI was also stated as an annual amount.

Let’s take a look at how DSCR might change over time.  The chart below tracks the DSCR of a real estate asset that is secured by two loans.  The first position loan is a constant payment with a fixed interest rate and a the second position loan is interest only payable monthly with a variable interest rate floating on Prime with a 5% floor.

Let’s see what we can learn from the chart.

• In the beginning of the year in 2008, the asset was not covering its debt service.  There was not quite enough NOI to cover its debt service with a DSCR of about .99.
• As the Prime rate was falling during 2008, it began to better cover its debt service because the debt service on the 2^nd position loan was falling inversely with Prime until the 2^nd position loan hit its interest rate floor of 5%.
• NOI increased between 2008 and 2009 and the DSCR leveled off.  It’s now barely covering the debt service with a DSCR of about 1.04.

Do you know the Debt Service Coverage Ratio for each of your real estate assets and for your entire portfolio of real estate assets?  Calculating the DSCR for each of your real estate assets can be time consuming and the calculation keeps changing over time as your debt balances change and the NOI changes.  You don’t need to be a mathematician or hold an MBA to calculate your own DSCRs.  Consider using debt management software.  Your loan transactions are initiated from within the system and are automatically imported into your other financial systems.   By maintaining current loan balances and current interest rates in the debt management system, you can calculate the DSCRs for each of your assets and portfolio and much, much more at the touch of a button.   Portfolio Debt Manager is the First in Debt Management Software.  Check us out at www.portfoliodm.com.

Often a real estate investor will use debt to finance a real estate investment because he or she may not have enough equity capital for the entire value of the real estate asset.  Once the real estate investor commits to the decision to use debt, he or she should consider the effect of the debt as it relates to the overall return of the investment.  This concept is known as financial leverage.

Financial leverage is defined as the magnification that may result to a real estate investment by borrowing at an interest rate that is lower than the expected rate of return of the asset unlevered, which is without debt.  This is positive financial leverage.  Negative financial leverage is obtained by borrowing at an interest rate that is higher than the expected rate of return of the asset unlevered.

To measure financial leverage accurately, we need to be able to determine the purchase price or cost of the asset, the after tax stream of income (after paying the debt service), and the after tax liquidation value of the asset.  In most cases, we can only guess at the future streams of income and the liquidation value, so to be exactly accurate, we would need to wait until the asset is sold to exactly determine financial leverage.

However, we can approximate financial leverage by ignoring the purchase, the sale, and the tax implications by comparing a simple return of the unlevered income stream with the interest rate of the debt (a weighted average borrowing rate if more than one loan exists).  In most cases, a real estate investor has a pretty good notion of the value of its asset and can predict with a fair degree of certainty what the asset’s Net Operating Income (NOI) is or will be by looking at the past or by budgeting into the future.  NOI is defined as the income generated from a real estate asset minus the operating expenses necessary to operate the asset, but before the deduction for debt service, depreciation, and taxes.

Let’s say we want to know for the next 12 months a quantitative measure of financial leverage for a particular investment.   Here are the assumptions:

For each interest calculation in the 12 month period, we need to subtract the interest rate from the unlevered return and apply the difference to the outstanding principal balance at each payment period and then sum up each result over the 12 month period. The unlevered return is calculated by dividing NOI by the asset value.  Take a look at the formula:

Here is the result in table form:

From the data we can see that by using debt, our investment example will generate an additional $18,972 of return over the next 12 months compared with the absence of debt.  When making these calculations, a real estate investor can begin to think about the risks and rewards concerning his or her borrowing methods.  Nearly $19,000 of extra return relative to a debt balance of nearly $5,000,000 seems pretty slim.  If there is any kind of risk to this investment’s NOI over the next year, one should take pause before adding the debt.

Do you know the measure of financial leverage for each of your real estate assets and over your entire portfolio of real estate assets?  Calculating financial leverage for each of your real estate assets can be time consuming and the calculation keeps changing over time as your debt balances change.  You don’t need to be a mathematician or hold an MBA to calculate financial leverage.  Consider using debt management software.  Your loan transactions are initiated from within the system and are automatically imported into your other financial systems.   By maintaining current loan balances in the debt management system, it can calculate financial leverage and much, much more at the touch of a button.   Eliminate the management of your loans with spreadsheets, obtain instant access to your loan balances, end the need to clean up errant loan transactions made by your staff, and add an MBA to your staff without adding the salary.  Portfolio Debt Manager is the First in Debt Management Software.  Check us out at www.portfoliodm.com.

Often a real estate investor will want to calculate the cost of borrowing for a particular real estate investment or real estate portfolio.  If a project or portfolio only has one loan, the borrowing cost is simply the interest rate of the singular loan.  However, often a project or portfolio will have more than one loan.   The real estate investor may want to identify which investments could be advantageously refinanced by comparing the interest rate of a new financing alternative to the weighted average interest rate of the existing financing.

We’ll use the formula for the Weighted Average Cost of Capital to find the blended rate.  The formula is as follows (where n is the number of loans of the asset or in the portfolio):

To summarize, we are going to sum the result of multiplying the effective interest rate of each loan by its respective outstanding principal balance and then dividing it by the sum of the outstanding principal for each loan.

The method of interest calculation can vary between the loan types for the project or portfolio.  Therefore, before we can make the calculation we have to convert the interest rates to one method so that we are comparing apples to apples.  The table below shows the some common methods of calculating interest and how to convert each type to a common method.

In the Interest Calculation Type column, the first number represents the number of days in the compounding period.  A 365 represents that the calculation will be made using the actual number of days in the compounding period.  The second number represents the number of annual days to divide the annually stated interest rate by.  For lenders that divide the annually stated interest rate by a 360 day year, but charge interest on the actual number of days in the compounding period, we must convert the stated interest rate to a 365 / 365 interest calculation type.  Again, we need to be comparing apples to apples.

Let’s walk through an example.  Take a look at the loan assumptions in the table below:

First, we must convert the stated interest rate to an effective interest rate for Loan 1 using the Effective Interest Rate Equation.

Now, let’s calculated the blended borrowing rate using the WACC equation from above:

For our example, the weighted average borrowing cost is 6.47%.  In the case of determining whether to refinance these two loans into one, we may want to compare the effective interest rate of the new financing alternative with the result of our calculation as part of the decision making process.

Do you know the weighted average borrowing cost for each of your real estate assets and for your entire portfolio of real estate assets?  Calculating the weighted average borrowing cost for each of your real estate assets can be time consuming and the calculation keeps changing over time as your debt balances change.  You don’t need to be a mathematician or hold an MBA to calculate your weighted average borrowing cost.  Consider using debt management software.  Your loan transactions are initiated from within the system and are automatically imported into your other financial systems.   By maintaining current loan balances and current interest rates in the debt management system, you can calculate the weighted average borrowing cost for each of your assets and portfolio and much, much more at the touch of a button.   Portfolio Debt Manager is the First in Debt Management Software.  Check us out at www.portfoliodm.com.

In the practice of real estate finance, there exist many different financing options.  This article will evaluate the differences between a Constant Payment, Constant Amortization, and Interest Only payment type and their affect on cash flow and debt repayment.   To illustrate these differences, let’s take a look at an example loan where the loan assumptions are found below:

For simplicity, let’s assume the term period and the amortization periods are the same; 25 years.  The Constant Payment is calculated to fully amortize the loan over the 25 year period, the Constant Amortization is arrived at by dividing the beginning principal by the amortization period, and the Interest Only payment is assumed to pay the interest that accrues during the monthly compounding period.  In the table below, we can compare the amount of interest paid over the life of the loan by payment type.

We can conclude that the Constant Amortization payment type requires the borrower to pay the least amount of interest over the life of the loan and that the Interest Only loan requires the borrower to pay the most amount of interest.  Given this result, let’s examine how the principal is repaid for the three different payment types.  The chart below details the debt balance for each year the principal remains outstanding.

From the Loan Balance chart, we can see that at any given year the loan balance for the Constant Amortization payment type is lower than the other payment types.  With the Interest Only payment type loan, the entire principal balance remains outstanding throughout the life of the loan and is only repaid at the end of the term period.   The Constant Payment type loan always maintains a higher outstanding principal balance as compared with the Constant Amortization type.

Finally, let’s examine the payment amounts for each loan type.  The Constant Amortization loan repays with a fixed amount of principal plus interest accrued during the compounding period, therefore the payments are higher during the beginning of the loan as the principal balance is higher affecting the interest calculation.  The chart below shows the amount of the payment for each type over time.

By definition the Constant Payment type does not change over time and remains at about $77,000.  The Constant Amortization type starts at the beginning of the loan at about $99,000 and reduces to about $41,000 at the end of the loan.  The Interest Only type remains at $60,000 until the end of the loan when the entire principal sum is repaid.  While the Constant Amortization loan seems the most advantageous as it requires a lower total payment stream, it is weighted for higher payments at the beginning of the loan and lower payments at the end.  The Interest Only type requires the lowest annual payment stream in the earlier years.  You can see that at about year 18 the payment stream of the Constant Amortization payment type is about equivalent with the Interest Only payment type.  After year 18, the Constant Amortization loan payments become the lowest.  You can see at the end of the Interest Only loan the entire principal sum must be repaid all at once.

Another payment type we haven’t discussed here is the Graduated Payment.  The Graduated Payment loan starts its life with a lower payment amount and it steps up once or more over the life of the loan.  The most common form of a Graduated Payment loan is a loan that starts as an Interest Only payment for a period of time then switching to either a Constant Payment or Constant Amortization payment type.

Stabilized real estate Net Operating Income typically grows over time as rental rates rise.  The most typical real estate loan is not conducive to a Constant Amortization loan as its payments are higher in the beginning and lower at the end while the real estate asset is better able to service the debt at the end then at the beginning.  Lenders like Constant Amortization payment type because it returns principal faster reducing lender risk in a like fashion.

To better understand your loans and their affect on the assets by which they are secured, consider using debt management software.  With debt management software, you can project the balances of your loans forward in time even if they have Graduated Payment types.  You can view the debt of your real estate assets, consolidate your asset debt to the portfolio level, and track it over time!  And much, much more at the touch of a button.  Portfolio Debt Manager is the First in Debt Management Software.  Check us out at www.portfoliodm.com.

In the practice of real estate finance, lenders have a few choices on how to calculate the interest charged to their borrowers.  In this article, we will explore the cost differences and the effective rates of three common types of interest calculations:  360 / 360, 365 / 360 (Bank Method), and the 365 / 365 (Stated Rate Method).  The first number represents the number of days in the compounding period for which interest is to be charged.  For 360, interest will only be charged on 360 days of the year.  If the loan calls for a monthly compounding period, interest will be charged on a 30 day month regardless of the number of actual days in the month.  For 365, the loan calls for interest to be charged on the actual number of days in the compounding period.  The second number represents the number of days in the year to divide the Annual Percentage Rate by.  For 360, the stated interest rate is divided by 360.  For 365, the stated interest rate is divided by 365.

To illustrate the differences, let’s use an example lending commitment.  The table below sets out our assumptions:

When we amortize each interest type to maturity and sum up the total interest that would have been paid over the life of the loan, we find that the lifetime interest paid for each type in the table below:

The most advantage interest calculation type to the borrower is the 360 / 360 followed closely by the 365 / 365.  The 365 / 360, when amortized over the 360 term periods, will cost the borrower an extra $37,460 (3.746% more) when compared to the 360 / 360 interest type.  Next let’s determine at what effective rate will cause each alternative to have the exact same lifetime interest cost.  The results are shown in the table below:

If a borrower is evaluating a financing proposal from a lender which charges interest the actual number of days dividing the stated interest rate by a 360 day year (365 / 360), the stated interest rate must be equal to or lower than 4.92853% to make it comparable or advantageous to the borrower when compared to the 360 / 360 interest calculation type.  The 365 / 365 type is virtually identical to the 360 / 360 interest calculation type.

In this example, we used a 30 year amortization term period.  If the loan calls for a shorter term, of say 10 years, the effective interest rates remain the same and the interest cost of the 365 / 360 loan will again cost the borrower an extra 3.746%.

This analysis was prepared in a matter of minutes using the Comparative Finance module of debt management software.  To better understand your loans and their affect on the assets by which they are secured, consider using debt management software.  With debt management software, you can project the balances of your loans forward in time even if they have Graduated Payment types.  You can view the debt of your real estate assets, consolidate your asset debt to the portfolio level, and track it over time!  Everything about your loans is at the touch of a button and much, much more.  Portfolio Debt Manager is the First in Debt Management Software.  Check us out at www.portfoliodm.com.

The accounting department for a borrowing entity typically does not record accrued interest in the correct accounting period for loans that the interest is accrued in one accounting period but payable in the next accounting period.  While this issue becomes moot for users of loan accounting software, most borrowers are still preparing loan accounting by hand.  For example, let’s say we have a permanent loan that interest compounds on the last day of each calendar month and the accrued interest is payable, along with some principal, on the first day of each calendar month.  In this example, the interest that accrues for the month of January at the end of January is typically recorded in February when the loan payment is made.  To comply with Generally Accepted Accounting Principles, the accounting department will typically at the end of the borrowing entity’s calendar or fiscal year record an entry to book the accrued interest for the last accounting period in the year.  In our example, let’s say the borrowing entity is on a calendar year tax basis.  To comply with GAAP, the interest accrued for December is recorded as a liability for the calendar tax year that ends in December.  The accounting department will reverse this entry in January of the next calendar tax year.  This method of loan accounting is tolerated because to correctly record the interest transaction the accounting department would have to record the accrued interest at the end of each calendar month and then record the payment on the first day of the calendar month.  This would require 10 extra entries (February through November accrued interest, in our example) making it impractical in a typical accounting department.

To make your loan accounting exactly correct consider using loan accounting software.  Because the loan accounting entries are made by the computer it becomes practical to post interest at the end of each accounting period and then subsequently pay the interest at the beginning of each accounting period.  With debt management software, your loan transactions are initiated from within the system and are automatically imported into your other financial systems.  You can more efficiently and accurately control your loan accounting and much, much more at the touch of a button.