The residential market’s “mortgage meltdown” has resulted in more cautious underwriting practices across the board. Banks can offer creative lending opportunities with many different loan products, including loans for owner-occupied properties that are backed by the Small Business Administration (SBA).
“We are seeing a fair amount of activity in this region with out-of-market investors coming in and buying commercial real estate,” says Craig Johnson, president and CEO, Franklin Bank, Southfield, Mich. “That’s good news for local owners of commercial real estate. This activity also confirms the value and return on investment you can realize if you are prepared to purchase either investment or owner-occupied real estate.”
Here, Johnson provides insight on how to navigate the commercial real estate loan process with ease.
How has the mortgage crisis in the residential market affected the commercial market?
Up until the mortgage meltdown, there was an active secondary market in commercial real estate loans. Large conduit lenders take a pool of loans, securitize them and sell them with terms that are typically a 10-year fixed rate with 25- to 30-year amortizations. However, over the past few months the conduit market became less active. As a result, banks are offering more opportunities for commercial loans that might have previously gone through this secondary market. In some cases, banks are providing shorter term loans because investors want to eventually transfer their loan to a long-term financing source. Keep in mind, however, that those long-term sources have heavy prepayment penalties you should consider before taking your financing to a secondary market.
What precautions do banks take with commercial construction loans to reduce risk?
Depending on the size and scope of the construction project, banks will typically send out their own inspectors to review architectural plans and bids. Inspectors then provide the bank with the assurance that bids and plans are appropriate, and that the building can be constructed with the budget being proposed. During the building process, inspectors will review the ongoing construction and provide the bank with periodic reports to ensure that the project is moving along as proposed.
If you are seeking a loan for residential land development, generally speaking, banks are steering away from that business now because of the slow market and mortgage crisis. In general, banks are gun shy and more conservative on the financing end.
Are there creative loan structures that enable business owners to pursue commercial real estate ventures?
While middle-market businesses do not always qualify for SBA-backed loans, it’s a good idea to review criteria on www.sba.gov to see whether your company may take advantage of these opportunities. The SBA 7(a) program allows borrowers to put as little as 10 percent down and secure up to a 25-year term loan with no balloons. These loans are for less than $2 million and available to finance working capital, including real estate. The CDC/504 program requires a 10 percent contribution from the borrower, the bank finances 50 percent and the remaining 40 percent is financed by a certified development company (CDC) that is 100 percent backed by the SBA. The CDC/504 program provides growing businesses with long-term, fixed-rate financing for assets like land and buildings. For both loans, there are limitations and qualification requirements. It’s best to discuss these options with your bank to determine whether your company is a fit.
What should a borrower come to the table with in this lending environment to ensure a smooth underwriting process?
First, you should expect to enter the process with 20 to 25 percent of capital to invest. Do your due diligence before approaching the bank, and be prepared to provide as much detail on the property as possible. Provide cash returns and cash flow statements on the property. If it is a redevelopment project, prepare information that describes your plans for the project and how you will reposition the property for success. Be sure the purchase contract includes appropriate inspection clauses; banks generally will require roof and mechanical inspections to ensure that water, electrical, gas and the structure of the building are satisfactory. Additional inspections will be required before closing, including an EPA Phase I environmental study.
If you already own real estate, prepare a detailed schedule of these properties as part of your personal financial statement. This should include details like original purchase price, current value, current debt, monthly debt service requirements and percentage ownership. This schedule gives the bank a complete picture of the type of assets you own, and whether those are diversified, wise investments.
CRAIG JOHNSON is president and CEO of Franklin Bank, Southfield, Mich. Reach him at firstname.lastname@example.org or (248) 386-9860.