Change in the air Featured

10:42am EDT July 30, 2006
Whether it’s the Trump World Tower or the Walgreen’s corner store, businesses have a significant connection to their property. While a company’s land and buildings sustain its current operations, they also can propel its future success.

Banks have special lending options to meet the needs of commercial real estate investors. Business owners can choose from many financing options including construction lending; short- and long-term loans and amortizations; business owner and user loans; investor and developer financing options; and fixed and floating rate mortgages, says Trent E. DeFrates, vice president and principal relationship manager for Wells Fargo’s Houston Business Banking Group.

“Some banks even have a streamlined equity loan or line for commercial property that allows commercial property owners to pull out some equity in their property, similar to residential single-family equity loans.”

Smart Business spoke with DeFrates about the significance of commercial real estate financing and how to respond to the current changes in the lending environment.

Why is real estate financing important to business owners?
Commercial real estate loans allow a business to own its facility instead of leasing it. This enables it to take advantage of tax benefits. Owners can deduct depreciation expenses, interest expenses and other eligible expenses. Most businesses maximize tax benefits by setting up a separate single-asset entity for the sole purpose of owning and operating real estate.

Construction financing gives businesses the ability to control the design of their facilities and take advantage of build-to-suit options that maximize the efficiency and productivity of their operations.

Real estate lending allows businesses to grow equity and value in their property, especially in high-growth, developing areas. If companies purchase additional land adjacent to their existing operations, they can expand their facilities during a growth cycle.

How can changes in the real estate financing environment affect businesses?
Interest rate risk in the present real estate market could be a problem for some business owners. This is especially true if they currently maintain a floating rate or a short-term adjustable rate on their commercial mortgages. Companies may have received a low initial rate by choosing an adjustable or floating rate mortgage. As rates increase, the rise in interest expense can negatively affect cash flows. To remedy this situation, the business may need to refinance into a longer term fixed-rate mortgage.

How would you describe the current real estate lending environment?
We are currently in a rising interest rate environment with no short-term end in sight to Federal Reserve rate increases. However, real estate debt still is readily available for owners of, and investors in, commercial real estate. This is primarily due to pricing competition between lenders. Many banks are fighting for market share, and some are cutting margins to keep customers -- especially in cases where the customer maintains a larger relationship with the bank.

How should business owners respond to the present situation?
In today’s environment, companies can choose between fixed- and floating-rate financing. This presents more of a dilemma than in the past. Securing a fixed rate always has been preferable for long-term investments, while borrowing with a floating rate has generally provided cheaper money on a short-term basis. The advantage of the latter has been marginalized due to the incredibly low fixed-rate loans currently available. Fixed-rate financing may be the best choice for this environment.

How can banks help companies prepare for future changes in real estate financing?
Many banks can assist businesses in this market by providing interest rate protection such as rate caps, which set a maximum interest rate for the loan; rate collars, which set both a maximum and minimum rate; and interest rate swaps, which establish a fixed rate. These enable business owners to prudently reduce the interest rate risk for their real estate loans.

How can banks assist businesses in maximizing their real estate financing potential?
A bank relationship manager should be able to advise business clients about options for real estate financing. Relationship managers can help businesses determine what type of financing is available to them and assist them in beginning the process of financing a building. It is important that this process is collaborative so that relationship managers can meet businesses’ specific needs. Business owners will need to answer these questions:

  • Do they intend to construct a building or buy an existing building?

  • Is there any known environmental impairment to the property?

  • Do they want to refinance an existing property to maintain a lower interest rate?

  • Are they trying to pull some equity out of their current property?

From this information, bank relationship managers can help business owners decide what type of rate to choose, how long to set the loan term and amortization and how much equity the business owners should invest into the property.

TRENT E. DeFRATES is vice president and principal relationship manager for the Wells Fargo Bank Houston Business Banking Group. He has 15 years of banking experience. Reach him at (832) 251-5515 or trent.e.defrates@wellsfargo.com.