Simply put, post close liquidity is the amount of cash and cash equivalents that the guarantor(s) of a loan will have left over after contributing their portion of equity required to close a transaction. Therefore, this calculation is generally specific to those that are signing as a guarantor of the loan even though there may be other partners.
A guarantor’s post close liquidity is one of the primary factors that determine how much loan amount they qualify for. This metric is important because lenders want to feel comfortable that the borrower on a transaction has enough cash reserves to cover any disruption in the property’s performance that may create a shortfall in loan payments. For instance, a construction or bridge loan may have delays or overruns in the process causing the property’s cash flow to ramp up slower than expected.
Barring the concerns over what lenders consider qualifying funds (which we will cover in Part II), the calculation is relatively simple. It is important to note that the requirement is on an aggregate basis for all of the guarantors. Therefore, you can add the calculation up for all signing parties when there is more than one guarantor in order to meet the required amount (generally without regard to whether or not all guarantors have equal ownership percentages). To calculate the total combined post close liquidity, follow these three steps:
Step #1 Generate the equity required to close the transaction (total cost minus the debt). Ask your lender or broker for the Sources and Uses on a transaction, or for a rough estimate use your purchase price plus 2.0% for losing costs (possibly higher for bridge loans if lender’s charge additional origination fees) and subtract the loan amount.
Ex. We’ll use a $5,000,000 purchase with 2.0% closing costs of $100,000. This results in a total cost of $5,100,000. A loan amount of 75% of the purchase price of $5,000,000 equates to $3,750,000. Total cost of $5,100,000 – $3,750,000 = $1,350,000 in required equity to close.
For bridge and construction loans, the capex and construction will be counted as hard costs for the transaction, but for value-add players that are otherwise putting capex into the deal electively, the lender likely won’t consider this in the Sources and Uses as it is not a requirement of their loan.
Step #2 Calculate the equity requirement for the guarantor(s) by multiplying the total equity needed to close times the legal ownership percentage that the guarantors have in the ownership entity.
Ex. We have two guarantors that are in the GP position on the transaction. Regardless of how much cash they are putting into the deal, they each have 10% equity for a total of 20% combined legal ownership. Their portion of the required equity would be calculated as $1,350,000 x 20% = $270,000. In theory this would mean $135,000 due from each of them.
For all you syndicators out there, we say the legal ownership percentage because we want to avoid the conversation of “While we are the guarantors, we are syndicating the deal and not putting any cash in up-front (or a mismatch of the equity you’re taking vs the cash you’re putting in) so all of the cash on our PFS will be there after close.” Not to say that there is anything wrong with this, but more than low leverage and high debt service coverage, lenders like “skin in the game” from the loan guarantors so it is best just to let them calculate it off of your legal ownership percentage without bringing up how it may be different unless ultimately necessary.
Step #3 Subtract the amount of each guarantor’s required equity contribution from the liquidity reported on their PFS. This will determine how much liquidity they will have available after the loan closes. Finally, add up the post close liquidity of each guarantor to get the total combined post close liquidity.
Ex. Guarantor A reports $180,000 in liquidity on their PFS and Guarantor B reports $475,000 in liquidity on their PFS. Per the calculation for the required equity from the guarantors, they each must contribute $135,000 at closing. Based on this, Guarantor A will have $45,000 and Guarantor B will have $340,000. This results in total combined post close liquidity of $385,000 (based on how the lender will calculate it).
To verify liquidity, lenders typically require two months of bank and/or brokerage statements to support the stated amount of liquidity from a guarantor. Generally, these statements need to be dated within the last 60 – 90 days.
In conclusion, post close liquidity requirements are one of the most important loan qualifications we deal with. It is very important to determine what the requirements for each loan program are before starting the loan process. Many loan programs are different in terms of their requirement and also what they will accept as qualifying liquidity. We will cover these topics in Part II of our post close liquidity series! As always, a strong broker that understands the requirements of the different loan programs can be a great resource.