Commercial Loans

Commercial mortgage borrowers often ask us how lenders determine the rates that they offer on commercial mortgage loans. There are many criteria that lenders use when determining rates, but lenders will assess the relative risk of a loan when reviewing a loan application. The lower the risk, the lower the rate. The higher the risk, the higher the rate. It is important to understand what factors are important to lenders and underwriters.

– Borrower Qualifications. Lenders will analyze a borrower or guarantor’s net worth, liquidity, cash flow, credit history and real estate experience in determining overall risk. Lenders like to see borrowers with a good history owning and managing similar properties. They want to see sufficient cash reserves to cover unexpected issues that might arise and they expect to see that borrowers have a good history of paying their bills in a timely matter.

– Property location and market. Good quality properties in large metropolitan and suburban areas are considered lower risk than inferior properties and properties in small rural locations. Good properties in good locations are easier to rent in the case where tenants move out or situations where the remaining lease terms are short. For example, if a property in a poor location becomes vacant, it will require a significant amount of renovation to attract new tenants.

– Tenant mix. Multi-tenanted properties with good quality tenants and long-term leases are very desirable when financing office and retail properties. Lenders do not like vacancy, high turnover rates and properties in a constant state of flux. Lenders like to see well run properties that attract and maintain long term tenants

– Stabilized occupancy. Lenders look for properties that have enjoyed high occupancy levels with minimal disruption for the last 2 to 3 years. Properties with vacancies and fluctuating rental histories are considered higher risk. Lenders will ask for operating statements for the past 2-3 years. They expect to see steady occupancy and increasing net income. Properties that fluctuate wildly with income and expenses will generate lots of questions.

– Property Condition. Properties in good condition with little deferred maintenance are considered lower risk than properties in need of major capital improvements. Properties in poor condition will usually require that the lender set aside or escrow funds for repairs and maintenance. Properties in poor condition tend to perform worse than well maintained properties.

– Leverage. Loan-to-Value is very important in determining risk. A 50% LTV(loan to value) loan will price better than a loan at 80% LTV. If a property experiences difficulty, there is much more room for error on low leverage loans.

-Debt Coverage. This refers to the excess in net operating income over annual mortgage payments. The more excess cash flow a property produces, the lower the risk. Excess cash flow can be used to mitigate against turnover, repairs or other cash drain.

At the end of the day, lenders do not want to expose their lending institutions to undue risk. A borrower should be prepared to address all of these issues to the satisfaction of the lender at application in order to increase the chances of getting approved for a loan at the lowest rate possible.

Once you are qualified for a commercial mortgage loan, it is helpful to get an idea of your proposed monthly payment in advance. A commercial mortgage calculator is a very helpful and useful tool. Whether you are purchasing a new commercial building, or refinancing an existing commercial loan, it is helpful to know how much of a loan you can afford at today’s rates. A commercial mortgage calculator will calculate your monthly payment for you. You will be asked to enter the loan amount, number of years, and interest rate. The mortgage calculator will calculate your monthly payment.

“I pay for everything in cash, I never finance anything” or “I’ve never had to take out a loan, I don’t believe in it”. Every so often, I encounter this type of feedback from a business owner. The attitude usually goes along with a strong, hands-on work ethic for an owner which has built their business from the ground up. They have worked long hours, suffered through the ups and downs and sacrificed family time and vacations to make their business survive. Their belief is, if they cannot pay for something with cash then they do not need it.

I respect the energy and devotion but I also take note that the strategy seems to apply to small, family owned businesses with a small number of employees which have remained flat in their growth and have stopped expanding years ago. Expansion and reaching new markets are not typically part of their business plan and they are happy with a fixed income often servicing the same clientele they have for years.

The downside of never financing anything is the limited amount of expansion which can occur. In essence, they cannot grow beyond what is in their bank account at any moment in time. For example, a small business with $100,000 of capital desires to purchase a new $40,000 machine which will speed up production or bring them into a new market or simply replace an old machine; if they decide to pay cash that will leave them with $60,000 in cash reserves. If they encounter an emergency which requires $30,000 then that will leave them with little cash cushion in their account. They have also limited themselves in the case if another opportunity should surface at the same time they would not be able to take advantage of it like paying early for inventory to get a good discount.

The other negative of never borrowing is that your business will not have any established comparable credit so in the case when you do decide to finance anything, the likelihood of getting approved is marginal. A lender will not be able to assess your ability to pay back debt since you have never had any. Some business owners feel it should be viewed positively that you have never had to borrow but in the finance world it is not a positive. No credit history equals no loan.

The mantra in financing is ‘it is easier to finance equipment than it is money’ which is primarily true. Yes, you can get low cost capital from your bank if you have an established credit line but that line will have a limit. It is not a good move to use your credit line to finance an asset or equipment because that line should be used as either a last emergency resort or for short term borrowing. Finance rates are now in the 4-6% which can be stretched out to 5 years and sometimes longer. Many times, when expanding in a careful and planned manner, the finance payment will be less than the added revenue of your new equipment. This is true of energy and cost efficient industrial machines, solar systems and LED lighting.

Financing equipment for your business offers you the opportunity to expand, create more profit and reach new markets and clients. For those that want to know the benefits of never financing anything it is this; you will never owe anybody anything, no monthly payments, no interest and no chance of borrowing more than you can pay back but in that perceived safety there is also some risk and missed opportunity.

Early December 2015, J.P. Morgan announced a strategic partnership with OnDeck Capital, an alternative lending company, to originate, underwrite, and distribute loans that are targeted specifically at small businesses. The news impacted the banking world, as evidenced by a 28% single-day spike in OnDeck share price and has long-term implications for alternative lenders – of which hard money lenders are a core part.

The partnership scared many private lenders into worrying that major banks may be thinking of controlling their realms. JP Morgan’s partnership with OutBack does seem to indicate as much. Banks are already large. Are they going to take over alternative lending, too?

On the one hand…

Banks, such as JP Morgan, do have definite advantages over direct hard money lenders. And they know it. These include the following:

Product Construct. The biggest names in the traditional lending institutions, such as Charles Schwab or Bank of America, are able to afford giving clients long-term loans and lines of credit that sometimes extend to five or more years. In contrast, alternative lenders who fund from their own pockets can only supply loans that at best cap three years. These suit people who are desperate for some sort of money even if ‘short term’. Banks have the advantage in that their loans last longer for cheaper rates. Moreover, some major banks (such as Wells Fargo) have recently rolled out evergreen loans with no maturity date. This makes it harder for direct hard money lenders to compete.

High interest. Pricing hard money lenders charge notoriously high lines of credit – think of somewhere in the 70-80 percent range. Traditional banks, on the other hand, half this. To put that into perspective, consider that one of Bank of America’s basic small business credit cards (MasterCard Cash Rewards) carries an APR range between 11 and 21 percent – not for a term loan or line of credit, but for a credit card! Alternative money lenders may advertise their business by touting their efficiency and impressive speed, but it is the high interest factor that deters potential clients. And once again banks have the upper hand.

Borrower Risk Profile. Banks only accept applicants who they are convinced can repay. Banks consult credit history and FICO score to determine worthiness. Hard money lenders, on the other hand, get their business by taking on the more fiscally risky cases. As a result, and not surprisingly, hard money lenders have a median range of 16% default with forecasters predicting that many more borrowers will default in 2016 as prices stretch still higher. In short, one can say that banks bank the ‘cream of the crop’. Hard money lenders, on the other hand, tend to take the ‘cream of the crap’ (because those borrowers are the ones who usually have no option) and, sometimes, although not always, lose accordingly.

Macro Sensitivity. Just yesterday (December 16, 1015), the Federal Reserve issued its long-expected interest rate hike. The increase is insignificant (from a range of 0% to 0.25% to a range of 0.25% to 0.5%.), but it adds to an already onerous private lending interest rate. The slight increase may add little to the impact of the banks. It adds a lot to the already high interest rate of the private money lender.

Furthermore…

Most of all, banks have access to troves of data that private hard money lenders lack. Data banks include the years of experience and libraries of accounts, spending, and risk data. They are therefore able to underwrite credit with more predictive certainty and confidence.

Banks also have diversification and connection to one another. They are one homogenous body with access to shared information. Hard money lenders lack this. They’re theoretically unable to assess a single borrower’s creditworthiness based on metrics captured from a variety of bank-offered products.

On the other hand…

This is not to say that banks are going to dominate the industry of hard money lenders and capture their business. Hard money lenders have succeeded as evidenced from their growth and the industry is becoming more stabilized. Tom SEO of TechCrunch.com predicts that unconventional lenders – hard money lenders among them – will survive and may even thrive. This is because of three things that are happening right now:

When you put the terms hard and money together you think that it is something that will not be easy to get. Hard money is normally money that is required when things are in dire straights. These are primarily used for commercial properties. There are risks with all loans. That is why it is important to properly research your home or commercial property loans when you need them.

There have been times where, based on credit, we could not qualify for any loans for any type of property. A hard money loan is not necessarily based on credit. The collateral that we would use for this type of loan is the property. This money is normally fronted by investors and not banks. One of the big differences between banks and investors is that investors already have in mind the amount of money they need to make the deal worthwhile. Don’t get me wrong. Banks make money too. Normally, the investor that gives a hard money loan has a percentage of profit that they need to make. For others, it may be used as a rental property. In this case, the investor is interested in long-term gains.

Hard money loans are also different from the cash for a home sale. In your cash for home sale, you get an offer on your home within 72 hours and close within a month. There are no closing costs, no realtor fees, and no repair costs. However, you will get less than retail value for the home. The investors purpose in purchasing the home is to find an upside and profit from it.

Hard money loans are loans that are sometimes used when a commercial property is in distress. Unlike home loans, hard money loans rely on the potential sales price of a piece of commercial real estate. The potential investor that is considering lending you the money is not going to look at the appraised value of the property. They are going to look at what the future sales price will be if the commercial real estate has to be sold shortly after making the loan. Depending on the condition of the property, this loan will typically be between 50 and 75 percent of the appraised valued of the commercial property.

The toughest part of dealing with a hard money loan is that you have to know if you can turn the situation around in a few months. There has to be a plan of success that will turn the business around in a short period. I do not know if investors want you to succeed or fail. It appears that if you are not successful in utilizing the loan for the success of your commercial property, investors expect to make some type of profit on their end if they have to take over the property.

It seems that hard money loans are fairly easy to get if there is a good chance of profit for investor from equity appraisal. For the business, their profit is based on doing what is necessary to keep the commercial property and paying off the loan. Hopefully, by paying off the loan timely, they are positioned for continued success.