East West Commercial Real Estate

Are you unrealistic in your expectations? If you have been on a deserted island, just landed on this planet or been living in a cave somewhere for the last couple years, you may have some notions that anything goes and you get a commercial loan approved and funded. This is what is known as unrealistic expectations.

If you think that statement has some humor in it, I have to tell, that everyday I am dealing with brokers and borrowers who fit that description. Worse yet, they are failing to recognize the gravity of the economic situation and how that affects underwriting and credit risk assessment or credit risk management.

You want a commercial loan for your client or yourself, now what? The first and foremost idea that you need to get in your head is that you have no control over the process or terms. This is not a borrower’s market–it is a lender’s market. In simple terms, you don’t have much ability to negotiate terms and/or conditions with a lender because the lender can afford to be very choosy it what they will approve and fund.

What do you need to know about lending today?You may have read news articles or heard stories on the TV and radio news programs on how the residential real estate values have nose-dived across the nation. Being a homeowner myself is not the greatest news to be constantly reminded of. But how does this affect commercial lending? In a word: Directly. As house values drop so do commercial values. This means that lenders are going to consider that dropping values is going to be a continuing trend and lending maximums are going to be reduced to off-set the risk of devaluation of property.

Translated, this means that the maximum LTV (Loan-to-value. The ratio of value to equity to what you owe on the property) is going to be scaled back to anticipate dropping values. In addition to that adjustments, lenders will also reduce the maximum loan amount you can obtain. Finally, the lender will limit certain types of transactions to even more restrictions to protect against anticipated losses.

Note the word  anticipated. In this type of economy, anticipated can be better associated with ‘fear of’ rather than anything positive

What are the SEVEN triggers lenders are looking at in approving your commercial loan?

1) CASH: They want to see that you have ‘skin’ in the game. The lenders are typically looking at you have at minimum of 25% equity position into the transaction.  Exceptions to this would be under SBA, which has a minimum cash position of 10% into a transaction.

2) CREDIT: They want to see strong credit for all of the principals (those who own 20%+ of the company). This means no mortgage late payments of any type. No prior foreclosures, short sales, settled, collection, charge off or other negative items. They do not want to see the personal credit maxed out either or a lot inquires into credit over the past 12 months.

3) RESERVES: They want to see strong net worth with at least 10-20% of the proposed loan amount in liquid assets.

4) CASH FLOW: The property must cash-flow at above minimum DSCR requirements, especially if the mortgage applied for is a variable rate. If the DSCR required is 1.20, expect the credit officer to look at ability of the property to handle rate increases at least 2% above the start rate in relationship to the DSCR. If the DSCR at start rate is meeting the minimum, the credit officer will easily determine that if the rate goes up 2%, the property will no longer meet the minimum DSCR and therefore decline the loan.

5) STABILIZATION: Business must have stabilized or increasing income/profits. A transaction showing declining income or increasing vacancy will be a big trouble sign and will more likely than not lead to a decline–even if all of the the other components are stellar.

6) PROPERTY/BUSINESS TYPES: The more general the property type, the more likely it is it will be approved. Single tenants, single use or special use property types and properties/business types that suffer more dramatically in tough times are harder to close to impossible. Examples of difficult properties would be; auto dealerships, hotel/motel, restaurant/bar, land/lot loans, construction projects of any type, properties where owners/tenants are real estate/mortgage and or finance companies or rehabilitation projects.

7) CASH-OUT REFINANCE: Cash our mortgage are another sore subject for lenders today. In most cases cash out is going to a cause for decline, especially if the reason is for ‘working capital’ (again SBA 7(a) line of credit maybe the best option here). However, if the cash out is reasonable (10-20% of the total loan amount) and the reasons make sense (buying out partners, consolidation of business debt, acquisition of additional property), then cash out is still available.  

What if you get a LOI or Conditional Approval and you don’t like it?I suggest you take the deal and don’t look a gift horse in the mouth. The financing you are taking today isn’t forever. You may have to take it (like it or not) because that may be the only offer you are going to get. I have seen too many people blow off an offer only to circle back around later to see if the offer is still available, only to find out it was a one-time deal.

Case study:We had issued a Conditional Approval on a deal where the borrower’s bank had refused to extend the balance of their loan to complete the renovations to their property. Our  Conditional Approval allowed up to $725,000 in cash out to complete the work and up to 80% LTV with a rate of Prime plus 4.5% to be fixed for 5-yrs with a 5-yrs step down prepayment penalty.  The borrower rejected the terms citing rate too high and terms to stringent.  45-days late the borrower requests that we re-instate the CA because they can not find financing and their current lender has called the loan due. We told the client that a new CA could be issued, however the rate would now go to Prime + 5.45% and the maximum LTV has been reduced to 70% LTV which meant that they would only be receiving $510,000 in cash proceeds to complete their project. Borrower rejected the second CA. The last we heard is that the borrower is now being foreclosed on by their current lender.

Although this case study may seem extreme and is unfortunate however, I am afraid that it will become a more common story line as this economic crisis continues.

Visit our web portal for more on the commercail financing that we currently offer. www.mycommerciallendingpro.com