When a property fund's loan matures into a smaller one, a buyer of an interest inherits its share of the gap, and a price quoted on NAV hides it.
Price the interest on the cash flows that follow the cure, not on the reported NAV: size the gap at the lender's new LTV on spot value, decide how it will be filled, and put your share of any capital call in the cash flows as an outflow. On an illustrative 20.0m interest in a fund that must refinance 200.0m of debt with a 162.0m loan, a 13 per cent buyer pays 13.20m, 66.0 per cent of reported NAV. Ignoring the 3.80m call it will have to meet leads to a price of 16.56m, overpaying by 3.36m.
Worked in full in The Real Estate Secondaries Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A closed-end property fund in its later years often carries debt fixed when rates and values were better. When the loan matures, the lender sizes the new one on today's value at today's LTV, and the difference has to come from somewhere: the investors, a preferred equity provider, or asset sales. A secondary buyer steps into that obligation with the interest. If the gap is in the next year or two, the reported NAV says nothing about who pays it, and a price quoted as a percentage of NAV hides it completely.
| Input | Value |
|---|---|
| Gross asset value, last appraisal | 400.0 |
| Value today, buyer's and lender's view | 360.0 |
| NOI a year, flat | 21.6 |
| Debt maturing at end of year 1, rate | 200.0 at 4.0% |
| New loan: maximum LTV, rate | 45% at 6.5% |
| Preferred equity alternative, coupon | 12% |
| Interest bought: share of fund | 10% |
| Buyer's target return; years to exit | 13%; 3 |
The fund sells at the end of year 3 at today's value. All figures are fictional and the case leaves out fees and carry to isolate the refinancing.
1. Reported NAV = 400.0 − 200.0 = 200.0; the interest is 20.0. At today's value, NAV is 160.0 and the interest 16.0. The LTV is 50.0 per cent reported, 55.56 per cent on spot value.
2. New loan = 45% × 360.0 = 162.0. Gap = 200.0 − 162.0 = 38.0; the interest's share is 3.80.
3. Year 1 cash to the fund: 21.6 − 8.0 of interest = 13.6. With a pro rata call, the interest receives 1.36 and pays 3.80: net −2.440.
4. Years 2 and 3: 21.6 − 10.53 of interest on the new loan = 11.07, or 1.107 to the interest. Exit in year 3: 360.0 − 162.0 = 198.0, or 19.8 more.
5. Price = PV at 13% of −2.440, 1.107 and 20.907 = 13.20. In Excel, =NPV(13%,B2:D2).
| Case | Price | % of reported NAV | % of spot NAV |
|---|---|---|---|
| Old loan extended at 4.0% (no refinancing) | 14.30 | 71.5% | |
| Refinanced in full at 6.5%, no gap (reference) | 13.56 | 67.8% | 84.8% |
| Gap filled by a pro rata capital call | 13.20 | 66.0% | 82.5% |
| Gap filled by preferred equity at 12% | 13.25 | 66.3% | 82.8% |
| Mistake: new loan, gap ignored | 16.56 | 82.8% | 103.5% |
Read the bridge from the top. The 10 per cent fall from appraisal to spot value and the buyer's 13 per cent target take the interest to 14.30. The higher rate on refinancing costs 0.74. Filling the gap with a call costs another 0.36, because the 3.80 put in earns only the 6.5 per cent interest it saves, not the buyer's 13 per cent. The 34.0 per cent discount to reported NAV is almost all value and rates, not the gap itself, provided the gap is in the cash flows.
Preferred equity at 12 per cent prices slightly higher than the call, 13.25 against 13.20. To a buyer whose own money costs 13 per cent, a 12 per cent provider is cheap; the two cures break even at a 13.00 per cent coupon. A buyer with a lower target would prefer the call.
| Max LTV | New loan | Gap | Price, call | Price, pref |
|---|---|---|---|---|
| 40% | 144.0 | 56.0 | 13.02 (65.1%) | 13.11 (65.5%) |
| 45% | 162.0 | 38.0 | 13.20 (66.0%) | 13.25 (66.3%) |
| 50% | 180.0 | 20.0 | 13.37 (66.8%) | 13.40 (67.0%) |
| 55% | 198.0 | 2.0 | 13.54 (67.7%) | 13.55 (67.7%) |
When the gap is correctly priced, its size moves the price modestly: an extra 18.0 of gap costs about 0.17 on this interest. What it does change is the cash the buyer must have ready within a year, and the risk that the cure is not available at all. If the fund has no unfunded commitments left to call and no provider will lend, the remaining route is selling assets into the market, which is a different and usually worse price.
The tape-based model, with the refinancing headroom and the scenarios of the book, is in the free workbook for this case. For the in-place debt as a value in its own right, see how to mark fixed-rate debt to market in a fund NAV.
Take the debt maturing and deduct the largest new loan a lender will make on today's value at today's LTV. In the illustration, 45 per cent of a 360.0m value is 162.0m against 200.0m maturing, a 38.0m gap. Sizing it on the 400.0m appraisal instead would show only 20.0m.
It depends on the buyer's own cost of capital. A capital call uses the buyer's money, which costs its target return; preferred equity costs its coupon. For a 13 per cent buyer, a 12 per cent preferred prices the illustrative interest at 13.25m against 13.20m with a call, and the two break even at a 13.00 per cent coupon.
Whoever the purchase agreement says, which is why it must be explicit. Usually the buyer bears calls made after the reference date: the seller funds them and is repaid through a price adjustment at closing, and calls after closing fall on the buyer directly. In the illustration the interest's 3.80m share of the gap is called within a year and is worth 3.36m today at 13 per cent: a bid that ignores it is too high by that amount.
This article is one calculation from The Real Estate Secondaries Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: real estate investing, finance and fund management → · All 1340 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.