This article discusses how an investment portfolio can help finance a real estate transaction via securities-based lending. Deciding how to finance a real estate transaction can be as important as deciding which property to select. Most people think of mortgages as the way to finance real estate, but that might not always be the right solution. Liquidating financial assets to cover a large purchase such as real estate is another approach, but it can involve costs that are not immediately apparent, including potential tax consequences,1 the loss of future asset growth and/or an imbalance in your portfolio’s asset allocation.2 A Different Way to Borrow If one takes an integrated approach to their financial needs, there are various potential solutions for credit and liquidity needs. One strategy is securities-based lending. When you establish a securities-based loan, you in essence unlock the value of your assets, allowing you quick and efficient access to funds (as long as there is adequate eligible collateral in the investment account). This may help you achieve a variety of real estate investment objectives, such as purchasing or constructing a primary or secondary home, financing a bridge loan to be used between selling one home and buying another, financing an investment in commercial or rental property or renovating your existing property. A Potential Viable Alternative to Home Equity Lines of Credit Prior to the financial crisis of 2008 and the subsequent housing market crash, some banks offered clients home equity lines of credit at 100% financing with low introductory interest rates and fees lower than mortgage costs.2 It was an inexpensive way to tap the equity in your home without refinancing your first mortgage. Then, when the real estate bubble burst and banks closed most home equity lines, those lines of credit disappeared along with the equity in the home. Some home equity lines of credit have a draw period, but once that period is up you can’t borrow more money and you must repay whatever you borrowed within the “repayment period.” Other home equity lines charge interest for a set period of time, but then charge an additional fee due at the end of the loan’s terms which may be so large that borrowers call it a “balloon amount.”3 By comparison, securities-based loans or lines of credit typically offer competitive interest rates that tend to be lower than traditional bank financing options such as such as mortgages and home-equity lines of credit and other forms of borrowing.4 With no origination, maintenance or facility fees paid to the Bank and no down payment required, securities-based loans may be a cost-effective alternative to traditional bank financing. Securities-Based Loan vs. Traditional Real Estate Loan—Illustrative Example* What does it look like to purchase real estate with a securities-based loan instead of a traditional real estate loan? This example highlights some of the potential key advantages to this approach for a buying a $5MM property. Securities-Based Loan Traditional Mortgage Loan* Purchase Price $5,000,000 $5,000,000 Down Payment $0 $1,000,000** Loan Amount $5,000,000 $4,000,000 Interest Rate*** 2.70% (L + 2.50%) 3.20% (L + 3.00%) Annual Interest $135,000 $128,000 Origination Fee $0 varies Funds Needed to Close $135,000**** $1,128,000***** *The chart is for educational purposes only. All client situations are unique and all loans are subject to application and approval. For this example, the Traditional Mortgage Loan represents a 1 Month LIBOR adjustable rate mortgage. **Assumes 20% down payment for bank financing, which is not necessary for securities-based loans. ***The interest calculation for a Securities-Based Loan is based on a LIBOR rate, which changes daily, plus an incremental percentage, which is determined by the approved loan amount. For this example, the LIBOR rate was 0.20% (as of April 3, 2013). The interest rate calculation for the Traditional Mortgage Loan depends not only on the interest rate, but also the outstanding principal balance from the month prior and the term. The calculation illustrated is a simplified estimate. LIBOR rates may be found at http://www.bankrate.com/rates/interest-rates/libor.aspx ****For letters of credit, there may be outside counsel costs for items such as the review of complicated trust agreements. *****Real estate fees required for traditional bank financing are not included in the example. Real estate fees include real estate report fees and outside legal fees. The origination fee represents an upfront facility fee. The specific size of the fee may vary depending on the transaction, and it may also fluctuate. Underwriting requirements may include appraisal, survey and title search fees. Total costs will vary depending on the specific transaction. Some or all fees may not be refundable. In addition to the benefits illustrated above, securities-based lending may offer other perks: The process of applying for and closing a securities-based line of credit can be faster than the process for a traditional loan and relatively simple. The applicant can be an individual or a legal entity, such as a family trust, LLC, LLP or General Partnership. There are flexible repayment options, including capitalizing the interest if you are borrowing for short term needs, paying interest only, or making payments to principal as desired. Many business owners find this helpful in managing seasonal cash flow for their business. Perhaps the most important benefit is that since your investments are not liquidated, you preserve your potential for the growth of your assets. There are risks associated with using your assets as collateral in a securities-based loan, and doing so is not beneficial for all clients. Sufficient collateral must be maintained and you may need to deposit additional eligible securities on short notice.2 For more information on these lending strategies and others, please contact Angel Chan, Private Banker with the El Camino Group for Morgan Stanley. 415-984-6006 1 Morgan Stanley and its Financial Advisors do not offer tax advice. Individuals should consult their personal tax advisor before making any tax-related investment decisions. 2 Securities-based Lending Risks: Borrowing against securities may not be suitable for everyone. You should be aware that securities-based loans involve a high degree of risk and that market conditions can magnify any potential for loss. Most importantly, you need to understand that: (1) Sufficient collateral must be maintained to support your loan(s) and to take future advances; (2) You may have to deposit additional cash or eligible securities on short notice; (3) Some or all of your securities may be sold without prior notice in order to maintain account equity at required collateral maintenance levels. You will not be entitled to choose the securities that will be sold. These actions may interrupt your long-term investment strategy and may result in adverse tax consequences or in additional fees being assessed; (4) Morgan Stanley Smith Barney LLC or its affiliates (the “Firm”) reserves the right not to fund any advance request due to insufficient collateral or for any other reason except for any portion of a securities-based loan that is identified as a committed facility; (5) The Firm reserves the right to increase your collateral maintenance requirements at any time without notice; and (6) The Firm reserves the right to call your securities-based loan at any time and for any reason. Asset allocation does not assure a profit or protect against loss in declining financial markets. 3 The Wall Street Journal, “Home Equity Lines and HELOCS – Getting a Good Deal” December 17, 2008 4The Wall Street Journal, “Putting Stocks in Hock: Securities Are Backing for More Big Loans” March 4, 2013. Morgan Stanley Smith Barney LLC is a registered Broker/Dealer, not a bank. Where appropriate, Morgan Stanley Smith Barney LLC has entered into arrangements with banks and other third parties to assist in offering certain banking related products and services. Banking and credit products and services are provided by Morgan Stanley Private Bank, National Association or Morgan Stanley Bank, N.A., members FDIC (the “Banks”). The Banks and Morgan Stanley Smith Barney LLC are affiliates. Investment products and services are offered through Morgan Stanley Smith Barney LLC, member SIPC. Unless specifically disclosed in writing, investments and services offered through Morgan Stanley Smith Barney LLC are not insured by the FDIC, are not deposits or other obligations of, or guaranteed by, the Banks and involve investment risks, including possible loss of principal amount invested. Article by McGraw Hill and provided courtesy of Morgan Stanley Financial Advisor. The author(s) are not employees of Morgan Stanley Smith Barney LLC ("Morgan Stanley"). The opinions expressed by the authors are solely their own and do not necessarily reflect those of Morgan Stanley. The information and data in the article or publication has been obtained from sources outside of Morgan Stanley and Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of information or data from sources outside of Morgan Stanley. Neither the information provided nor any opinion expressed constitutes a solicitation by Morgan Stanley with respect to the purchase or sale of any security, investment, strategy or product that may be mentioned. Morgan Stanley Financial Advisor(s) engaged Silicon Valley Latino to feature this article. Angel Chavez, CIMA® may only transact business in states where he is registered or excluded or exempted from registration www.morganstanleyfa.com/elcaminogroup/ Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where Angel Chavez, CIMA® is not registered or excluded or exempt from registration. © 2013 Morgan Stanley Smith Barney LLC. Member SIPC. CRC 648831 4/2013
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