Reference no: EM132784594

1. A participation loan is which the lender participates in the net operating income. To participate in the net operating income, the lender lowers the interest rates. In a way, the debt provider/lender becomes the equity partner because, in return of the lowered interest rates the borrower allows the lender to have a portion of the borrower's income. The lender may have a preference for a loan like this because it may protect them against inflation. This method acts as a hedge to prevent losses on their end in the event something unpredicted does arise. Net operating income and resale value operate much like inflation. If inflation were to rise, the rise in net operating income will compensate the loss of purchasing power in money. Also, the lender does not need to participate in losses.

2. Lenders might prefer a loan with a lower interest rate and a participation due to the lender receiving a percentage of one or more of potential gross income, net operating income, and cash flow after regular debt service. Also there might be a participation at the time the property is sold based on total sale proceeds or the appreciation in property value since when it was purchased. Uncertainty is associated with the participation since it is dependent on the performance of the property and if the property results in a loss the lender does not participate in the loss. A participation loan protects the lender from unanticipated inflation due to the net operating income and resale prices for income properties often increase as a result from inflation. Another preference would be if the borrower had a debt coverage ratio lower than 1.2 that most lenders at least require. (Fernando, 2021) With a participation loan the borrower could meet that debt coverage ratio from the lower interest rate when the conventional loan interest rates make the debt coverage ratio too low for lenders to consider the loan.