Senior Debt Deep Dive

Senior Debt: How Real Estate Loans Actually Work

Most real estate wealth is built on borrowed money. The senior mortgage is the primary tool. It funds 60-80% of a property's purchase price, and the terms of that loan shape the deal's cash flow, risk profile, and exit options for the entire hold period. Understanding senior debt mechanics is non-negotiable for any serious investor. The difference between a well-structured loan and a poorly structured one can be hundreds of thousands of dollars over a five-year hold.

Amortization: How Loan Payments Work

Amortization is the process of paying down a loan through regular installments of principal and interest. In the early years, most of each payment goes to interest. Over time, the principal portion grows. A $1M loan at 6% over 30 years costs $5,996/month. In month one, $5,000 goes to interest and $996 to principal. By year 15, the split is roughly even. By year 25, most of the payment reduces principal. Commercial loans typically use a 25-30 year amortization schedule but mature in 5-10 years, meaning there is a balloon payment due at maturity. You either pay the remaining balance, refinance, or sell.

Fixed vs. Floating Rate Debt

Fixed-rate loans lock the interest rate for the entire term. Your payment never changes. Floating-rate loans are priced as a spread over a benchmark, most commonly SOFR (Secured Overnight Financing Rate). A floating-rate loan priced at SOFR + 250 basis points means if SOFR is 4.5%, your rate is 7.0%. If SOFR drops to 3.0%, your rate drops to 5.5%. Floating rate sounds attractive in a declining-rate environment but becomes dangerous when rates spike. Many investors who took floating-rate loans in 2021-2022 at SOFR + 200 (total rate ~2.5%) found themselves paying 7%+ by 2023 when SOFR surged. That rate increase can eliminate cash flow and trigger covenant violations.

• Fixed rate: predictable payments, higher initial rate, no rate risk. Best for long-hold stabilized assets.
• Floating rate: lower initial rate, exposure to rate increases, requires a rate cap (insurance against spikes). Best for short-hold value-add plays where you plan to refinance.
• Rate cap: a derivative that limits your maximum rate. Required by most floating-rate lenders. Can cost $50K-$500K+ depending on the loan size and cap level.
• SOFR replaced LIBOR in 2023 as the standard benchmark. Check which SOFR variant your loan uses (30-day, 90-day, term SOFR).

Interest-Only Periods and the Balloon

Many commercial loans include an interest-only (IO) period of 2-5 years before amortization begins. During IO, your payment covers only interest, no principal reduction. This maximizes cash flow during the early years when you may be renovating, stabilizing, or leasing up the property. After the IO period, the loan converts to amortizing payments, and the monthly cost jumps. On a $5M loan at 6%, IO payments are $25,000/month. Once amortization starts (25-year schedule), payments jump to $32,200/month. Plan for that increase. At the end of the loan term (5, 7, or 10 years), the remaining principal is due as a balloon payment. If you cannot refinance or sell, you default. Maturity risk is real. It forced thousands of commercial properties into distress during 2008-2010 and again in 2023-2024.

Recourse vs. Non-Recourse

A recourse loan means the borrower is personally liable for the full debt. If the property is foreclosed and sold for less than the loan balance, the lender can pursue the borrower's personal assets for the deficiency. A non-recourse loan limits the lender's recovery to the property itself. Walk away from the property, walk away from the debt. In practice, non-recourse loans include 'bad boy' carve-outs that restore personal liability if you commit fraud, misapply funds, file voluntary bankruptcy, or breach environmental covenants. Agency loans (Fannie, Freddie) and CMBS loans are typically non-recourse. Local and regional bank loans are almost always recourse. The distinction matters enormously in a downside scenario.

• Recourse: personal guarantee, lender can pursue all personal assets. Common with banks under $10M.
• Non-recourse: lender recovery limited to the property. Standard for agency and CMBS loans above $5M.
• Bad boy carve-outs: fraud, voluntary bankruptcy, environmental contamination, and misapplication of funds typically trigger full recourse even on non-recourse loans.
• LTV constraints by type: multifamily 75-80%, office 65-70%, retail 65-70%, industrial 70-75%, hotel 55-65%.

Refinancing and the BRRRR Strategy

Refinancing replaces an existing loan with a new one, usually to access better terms, lower the rate, or pull out equity. In commercial real estate, refinancing every 3-5 years is standard because most loans mature in that window anyway. Cash-out refinancing is how investors recycle capital. Buy a property for $500K with $150K down. Renovate and increase value to $700K. Refinance at 75% LTV ($525K). After paying off the original $350K loan, you pocket $175K, more than your original $150K investment. You now own the property with zero of your original capital at risk, and the property still generates cash flow. This is the BRRRR strategy: Buy, Rehab, Rent, Refinance, Repeat. When executed well, it allows an investor to scale a portfolio using the same pool of capital over and over. The risk: if the property does not appraise at your target value, or rates have risen and the new loan does not cash-flow, the strategy stalls.