Hangout and Hangout Risk
The hangout is the expected outstanding loan balance owed the lender by the borrower at the end of the lease term of a key tenant, while the hangout risk is the risk to the lender associated with the borrower’s ability or inability to repay said loan. An especially important consideration in investments with a single tenant, the hangout risk is determined by comparing the hangout to the dark value (value of the vacant real estate) to determine whether the borrower will be able to repay the loan. This risk can be quantified by dividing the hangout by the dark value.
For example, a borrower secures a 100,000, 20-year loan against a property leased to WalBlues for 15 years. At the end of year 15, the outstanding loan balance is expected to be 50,000. The lender projects the value of the vacant property in year 15 to be 50,000. Therefore the hangout risk is high, as represented by the expected LTV at the end of the lease term (50,000 ÷ 50,000 = 100%), since the borrower will need to re-lease the property before year 20 to be able to refinance the property to repay the lender.
Putting ‘Hangout and Hangout Risk’ in Context
Evergreen Capital Partners, a private equity firm based in Denver, acquires Wasatch Retail Center, a single-tenant retail property in Salt Lake City, Utah. The property is leased to a regional big-box electronics retailer, TechMart, under a 12-year lease. Evergreen’s strategy is to hold the property as a stable income-producing asset with the potential for long-term value appreciation.
Scenario Overview
The acquisition is financed with a 70% loan-to-value (LTV) interest-only loan for 10 years. Evergreen acquires the property for $10 million, which includes land, building improvements, and site infrastructure. The loan amount is $7 million, and the lease with TechMart generates $750,000 in annual net rent, offering sufficient coverage for debt service during the initial lease term. However, the loan matures 2 years after TechMart’s lease ends.
This creates a hangout risk, as Evergreen will either need to re-lease or sell the property to cover the loan balance upon maturity.
Hangout Analysis
By year 10 (when the loan matures), the expected outstanding loan balance is $7 million, as no principal is paid down during the loan term. Evergreen projects the dark value (vacant property value) to be $6.5 million, based on current cap rates for vacant single-tenant properties in the region.
Hangout Risk Calculation:
The hangout risk is assessed by comparing the loan balance at maturity to the dark value:
Hangout Risk Ratio = Outstanding Loan Balance ÷ Dark Value
Substituting the values:
Hangout Risk Ratio = $7,000,000 ÷ $6,500,000 ≈ 107.7%
A hangout risk ratio exceeding 100% means the loan balance is greater than the value of the vacant property, highlighting that the borrower’s ability to refinance or repay depends heavily on re-leasing the property.
Implications for Evergreen Capital Partners
Evergreen identifies this as a moderate hangout risk, driven by the following factors:
- The short runway (2 years) to secure a new tenant or sell the property.
- The local demand for retail space, which Evergreen projects will remain stable, supported by Salt Lake City’s growing population and robust economy.
- The single-tenant nature of the property, increasing vulnerability to downtime between tenants.
To mitigate hangout risk, Evergreen plans to:
- Actively market the property for re-leasing starting in year 8, allowing 2-3 years for lease negotiations.
- Explore alternative strategies, such as selling the asset as a redevelopment opportunity, if TechMart does not renew its lease.
This scenario underscores how hangout risk can influence financing decisions and highlights the importance of aligning loan terms with tenant lease terms in single-tenant investments.
Frequently Asked Questions about Hangout and Hangout Risk
What is a “hangout” in real estate finance?
The “hangout” is the expected outstanding loan balance at the end of a key tenant’s lease term. It becomes critical when the loan term extends beyond the lease expiration.
How is “hangout risk” defined?
Hangout risk is the risk that the borrower will be unable to repay or refinance the loan at maturity, especially if the tenant vacates. It is measured by comparing the loan balance to the property’s dark value.
How do you calculate hangout risk?
Hangout Risk Ratio = Outstanding Loan Balance ÷ Dark Value. For example, a $7 million loan balance against a $6.5 million dark value yields a 107.7% hangout risk ratio.
Why is hangout risk especially relevant for single-tenant properties?
Single-tenant properties have no diversified income. If the sole tenant vacates, cash flow may cease entirely, making it harder to refinance or sell without a new lease in place.
What happened in the Evergreen Capital Partners example?
Evergreen had a $7 million loan on a single-tenant property leased to TechMart. The loan matured two years after the lease ended. With a projected dark value of $6.5 million, the hangout risk ratio was 107.7%.
How can investors mitigate hangout risk?
Mitigation strategies include aligning loan and lease terms, early re-leasing efforts, or planning asset repositioning. Evergreen, for instance, began marketing the space two years before lease expiration.
What does a hangout risk ratio greater than 100% indicate?
It means the outstanding loan exceeds the projected dark value of the asset, signaling high risk if the property is not re-leased or refinanced.
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