Home' Trinidad and Tobago Guardian : January 12th 2017 Contents BG18 | FINANCIAL ROAD MAP
BUSINESS GUARDIAN guardian.co.tt JANUARY 12 • 2017
When Kathryn's father
died she inherited a
property in a busy
building is 30 years
old and sits on two lots of rented land, which
her father was in negotiations with the land-
owner to purchase before he died.
Kathryn has taken up the mantle of com-
pleting the transaction only to be told the price
is $995,000, which is half of the estimated
The timing couldn't be worse as Kathryn
and her husband recently purchased their own
home and depleted all of their cash reserves
and exhausted their debt service ratio.
On the bright side, her father rented the top
floor of the building to a hairdresser at $7,500
per month whose lease recently expired. At
current rates the same space can fetch up to
$10,000 per month if some improvements
A potential tenant who owns a school fran-
chise is interested in the ground floor. To make
the place market ready Kathryn needs to gut
it out and rebuild, a project that is estimated
to cost about $150,000.
Once the works are completed the space
could earn up to 20 per cent more than the
top floor. The prospective tenant has offered to
contribute to the improvements if a concession
is granted with respect to the rent.
As a last resort after being turned down by
traditional financiers, Kathryn turned to Rob-
ert a good friend of her father's, a wealthy and
shrewd businessman. Personal relationships
aside, Robert said he would be willing to sup-
plying the capital if Kathryn's proposal was
When asked what exactly is attractive, Rob-
ert told her "well time is money."
Kathryn wants to secure her full rights to
her inheritance but she and he husband are not
inclined to offer part ownership as an option
to getting the money they need. Bearing this in
mind, Kathryn wants to know what proposal
she could make that would incentivise Robert
to part with his precious cash.
Sources of financing
A traditional lender's decision whether to
finance an income property based purely on
rents depends on their assessment of the relia-
bility of that income especially during periods
of vacancy or times when rent collection is a
problem, which often is the case with inex-
The lender would only consider a portion
of the rent as reliable and then a further por-
tion of this will be considered eligible for debt
servicing. These commercial type facilities
often have shorter terms and higher interest
rates than traditional residential mortgages.
Kathryn was probably turned down after the
numbers were crunched using the property's
debt service ratio, which may not have been
adequate to qualify for the amount of money
With traditional financing or joint ownership
with a potential investor not being options to
raise the capital needed, Kathryn's next best
alternative could be a private loan. She could
approach Robert for a loan but the question
is: what would he consider attractive?
Robert's loan considerations
We know that "Personal relationships aside"
Robert will consider an offer if it is attractive
which he will assess from the standpoint of
"time is money." However, this approach
sounds purely based on return on investment,
but would this be the only criterion that in-
fluences Robert's decision to part with his
The first objective of any investor or lend-
er should be to get a return of investment,
which speaks to risk. So, what are the risks
that Robert should consider when making a
loan to Kathryn?
Default: This is the first risk that any lender
would be most concerned about. Regardless of
how profitable the loan, the deal is only as good
as the borrower's ability to repay. In Kathryn's
case, this is dependent on her ability to collect
rents. This assumes that Robert is willing to
be more flexible than a traditional lender in
how much of the rent he considers reliable.
Robert would want to have legal recourse
to protect his rights as a lender should Kath-
ryn default on her loan. To do so, he should
have an agreement or promissory the strength
which depends on his ability to enforce and
recover his funds. To give him that assurance
he could put a lien (private mortgage) on the
Risk to the asset: Because the loan in ques-
tion will be significantly less than the value of
the land, the risk of fire or other perils to the
building would not affect Robert's investment.
However if the debt exceeded the market value
of the land then it would be advisable to have
the asset insured and the lender's interest
Inflation risk: Robert statement of "time
is money" rings true here because "a dollar
today is worth more than a dollar tomorrow"
which means that the longer the repayment
term the lower the buying power of future
debt payments. Robert has to ensure that the
return on his investment is attractive enough
to offset these effects.
Robert would want to ensure he could match
and exceed the returns he currently earns on
the funds he intends to withdraw to lend Kath-
ryn. If these funds are currently held in a short-
term, highly accessible and safe instrument
then the interest rate may be as low as 1 per
cent to 2 per cent per annum.
If he has no need for these funds in the near
future, then he may be willing to commit to a
longer-term (fully secured) arrangement with
Kathryn once the interest rate is greater than
what he earns currently and can compensate
him for the various risks discussed above.
If we assume that the projected average an-
nual inflation rate was 5 per cent and Robert
wanted to earn an extra 3 per cent per annum
to compensate for risks (total 8 per cent) this
could influence how long the loan lasts or how
much Kathryn would have to pay monthly.
Explore the option
of private loans
Assuming an annual interest rate of 8
per cent, a fixed monthly payment of
$7,500 and a loan amount of
$955,000 Kathryn would take
roughly 24 years to clear the debt.
If Robert wanted his money back in
10 years then Kathryn would have to
pay him $11,587 monthly; not
possible considering the current state
of the property.
If she committed the full $7,500 for
10 years she would have a balance of
$747,661 at the end of the term,
which she can agree to clear from a
sinking fund established from any
surpluses of rent over the period.
Seeing that the only way she can
increase the rent for the top floor to
$10,000 is to do the minor repairs,
maybe she can offer the tenant a
concession to do the fixes in lieu of
increasing the rent for a period of one
year and thereafter taking the
surpluses to establish the ground
floor or build up, a working capital
reserve or the sinking fund.
Using that same principle she can
entertain the offer from the
prospective tenant for downstairs
the rent concession in exchange for
the cost of the project.
If Robert was willing to advance the
money to purchase, do the minor top
floor fixes and the ground floor
renovations she could start collecting
the $22,000 in a few months then
pay it directly to the debt until
cleared. If she got say $1,150,000
($955,000 + $150,000 + $45,000
estimated top floor) and paid
$22,000 monthly at 8% per annum
she would actually take 5 years to
clear the debt.
If instead she chose to run the loan of
$1,150,000 at 8% for 10 years, her
monthly payments would be $13,953,
which means she would have a
positive cash flow of $8,047
($22,000 - $13,953) which she could
save for other projects or make
periodic lump sums on the debt.
Nicholas Dean (CertFa) is a certified
independent financial adviser and is the
Managing Director of The Financial Coaching
Centre Ltd. If you have any questions or
need advice on today's subject please email:
firstname.lastname@example.org or visit website: www.
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