The Refinance Assumption Trap
A deep dive on one of the most missed LP investment traps
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The Refinance Assumption Trap
I am often asked what assumptions LPs should look out for when looking at a deal. I am very hesitant to give specific guidance on these matters, because what tends to happen is that LPs will check whether those 1-3 “red flags” are present … and then invest on them not being in the deal.
I think this strategy (if you can call it that?) is deeply shortsighted, because all investments need to be looked at through the perspective of balancing the pros and cons of the transaction. The closest I’ve gone to giving such guidance so far is writing the Top 15 Syndication Mistakes article, and mentioning on several podcasts that many of the deals that are having challenges today assumed some degree of cap rate compression at the time of investment.
I have also seen many instances of cash out refinances today, a term that wasn't widely known until the past two years - more on that towards the bottom because it’s very related to today’s topic.
I keep seeing refinance assumptions appear in decks that have very material impact on IRRs. Although exit cap rates are the biggest place to slip up in most LP investments, it feels like refinance assumptions are a fairly close second.
Although exit cap rates are the biggest place to slip up in LP investments, it feels like refinance assumptions are a fairly close second.
Let’s dive in.