In lending, there are different ways to garner a real estate loan. Typically, people think only of banks, but loans are available from multiple sources, including pension funds, life insurance companies, credit unions, Wall Street and the government.
“There are lots of ways to get loans,” says Terry Coyne, SIOR, CCIM, an executive vice president with Grubb & Ellis.
Depending on the size and type of the investment you want to make, there are many different loan vehicles to help fund your commercial real estate purchase, he says.
Smart Business spoke with Coyne about what options exist to fund a commercial real estate purchase, from both an investor’s and an owner/occupier’s perspective.
What is important to know when it comes to financing commercial property?
In the commercial property market, if you’re an investor, you have a different goal than if you are an owner/occupier. An owner/occupier is much more interested in paying off the building and getting rid of debt, while an investor is more interested in cash flow.
Owner/occupiers are at the top of the pyramid as far as desirability to a lender because lenders like owner-occupied buildings. It gives them the security that the loan was used for the purpose for which it was intended and that there isn’t an absentee landlord. In addition to conventional bank loans, owner/occupiers can also harness life insurance, pension funds, commercial mortgage-backed securities, Small Business Administration loans and possibly opportunities from the state government, depending on the intended use of the commercial property. For instance, if you’re a manufacturer, you might qualify for the Ohio Enterprise Bond Fund, which is tax free.
How can owner/occupiers determine the right funding vehicle for their situation?
Typically, you will have a relationship with a bank, and that will help you get financing. There are also mortgage brokers who are paid to handle your entire transaction. There are many different companies in Northeast Ohio you can go to that will handle all of the applications and work with banks and other resources to come up with a solution.
But it really depends on your goal. For owner/occupiers, the bank you use for your daily needs is typically going to give you the best loan. That lender is often hard to beat because it knows you and wants to expand the relationship. However, you will probably end up with a recourse loan, which means you’re signing personally and the bank can come after you for your personal assets in the event of nonpayment. While bank loans will have the lowest interest rate and the highest loan-to-value, they’ll also typically have the highest risk because you’re signing personally.
How can investors assist?
Investors that are buying a building that is fully occupied will have many of the same options as an owner/occupier but will likely be looking for a lower interest rate. Because you’re an investor, you’re used to putting equity in a deal, so you’re likely willing to live with a lower loan-to-value. Banks will give you more money — typically a higher loan-to-value — than life insurance companies and pension funds because you’re typically not signing personally, so they need to protect themselves. They’re making a loan purely against the real estate and not against your ability to pay.
What are the pros and cons of each lending product?
Typically, bank loans have a lower interest rate with a higher loan-to-value than other products, but you’ll likely have to sign recourse. Also, the prepayment penalty, or the penalty for paying off the balance of the loan early, can be an issue.
Life insurance and pension fund money are going to have competitive interest rates that are comparable to those offered by banks but have a lower loan-to-value. Although less money is being advanced on the loan, you’re not obligated to sign a personal guarantee.
Another aspect is the amortization. If you go to a bank, it wants to amortize the loan as short as possible — 15 to 20 years maximum. A life insurance company will, in some instances, go 30 years, so your payments will be much smaller.
SBA loans are government-backed and made through a bank. They offer a greater loan-to-value than any other product and have very compelling interest rates. Also, you’d likely get a greater advance.
Commercial mortgage backed securities are loans from an entity that sells loans as a bond, which can be publicly owned. These bonds comprise hundreds of loans, of which a person owns a share. This market was huge until the crash, when it was discovered that no one knew what types of loans — or the ratings the loans had — that were inside these bonds. The commercial real estate side, however, wasn’t guilty of concocting crazy loans packages like the residential side was.
This market is back in a big way. It offers cheap money with very good terms on loan-to-value, which could be comparable to what a bank might offer, with similar interest rates and more amortization. The downside is that you can’t prepay, because they’ve guaranteed the bond’s investors a return. This means that if you sell your building soon after purchase, you won’t be able to pay off the entirety of the balance immediately without going through a complex process.
Lastly, there are lenders that are not regulated but that have private funds, hedge or otherwise, that will lend money for commercial real estate. They act like other lenders, but you’re usually going to them because you have a unique need that can’t be met by conventional lenders.
A mortgage or commercial real estate broker could help you tap into this type of financing.
Terry Coyne, SIOR, CCIM, is an executive vice president with Grubb & Ellis. Reach him at (216) 453-3001 or email@example.com.
Insights Real Estate is brought to you by Grubb & Ellis
In order to prosper in an increasingly competitive marketplace, it is essential to have a dedicated banking partner who is intimately familiar with your business needs and who can provide customized financial resources to grow your company.
A bank that doesn’t pay attention to your company’s needs and instead takes a one-size-fits-all approach may not be a bank that you want to build a relationship with.
“If clients have concerns about their banking relationship, that may be a good indication that they should look for a new banking partner,” says Alfred DeFlaviis, chief lending officer and senior vice president of First State Bank.
Smart Business spoke with DeFlaviis about how to identify a suitable bank and the importance of being prepared when seeking a loan.
What should a business look for in a bank when it is seeking a loan?
A business should look for a bank that takes the time to work with it and is interested in creating a partnership to help move the company forward toward achieving its financial goals. Find a bank that is familiar with the industry and geographic area in which the company operates and has other clients in similar industries. This allows it not only to tailor a package of financial products and services to the business but to share trends it has seen in similar companies.
How does the size of a bank influence how it does business?
National banks usually have a broad range of products and services and try to fit customers into their existing offerings rather than tailor products and services to fit the customer’s individual needs. Community banks have a lot more flexibility to offer customized solutions.
Take, for example, a company in need of many products and services that was doing business with a larger regional bank. The company was working with four individuals within the bank because regional banks tend to pigeonhole bankers into specialized categories, such as C&I loans, commercial real estate, small business loans, etc. The company’s leaders became confused as to whom they needed to deal with. Consequently, the package of financial products and services that was given to the customer by four internal bankers didn’t work. Individuals were selling their particular products and didn’t understand how all of them would work together to help the company achieve its goals.
Community banks, on the other hand, usually have one person, a commercial relationship manager, who coordinates products and services. That person will understand what a customer needs and create a package of products and services that meets the customer’s needs.
Because these institutions are smaller, the business owner may be able to talk directly with higher-level decision-makers to present his or her case. Larger banks have more rigid rules and processes associated with small business loans, and even if the person you’re talking to believes in you, he or she may not be able to help.
How can a business identify a suitable bank to partner with?
First, evaluate your existing relationship. Has your bank been responsive, acting not just as a lender but as a partner? If not, it may be time to find a bank that can work with you to grow your business. When making this decision, remember a community bank is knowledgeable about the community in which you operate and can make decisions based on that information at the local level instead of relying on decision-makers in another city.
After identifying a bank, how can you improve your chances of obtaining a loan?
Be prepared. Have a very clear goal of what you are trying to achieve. Existing companies should provide two to three years of historical financial statements/tax returns, for the business, related entities and owners. And all businesses should have a two-year business plan with a sales goal, profit goal and summary of business activities. Also have the assumptions used to derive those goals; if you are going to increase sales by 20 percent, specify how you are going to do that. If you don’t have a business plan, your banker should be able to help you develop one.
When obtaining a loan, what should a business expect from its banking partner?
Businesses should expect a high level of attention, both pre- and post-closing. Oftentimes, once the loan is closed, a bank and its client won’t communicate again until a problem arises on either side. Bankers and their clients should keep the lines of communication open, conveying information and building a partnership. A good lender sees customers regularly to make sure everything is progressing as planned based on discussions they had prior to the loan closing. In addition, the lender should be a consultant, helping the business expand and providing guidance.
A bank with good customer service should communicate with the borrower, at a minimum, on a quarterly basis. During these conversations, the business owner should convey to the bank how the company performed during that time period, whether it is on track with its business plan, how the bank’s products and services are working and whether there is anything the bank can provide to keep the company on track.
How has the downturn in the economy affected bank loans?
When the economy takes a turn for the worse, you must have confidence that you can get through the rough patch with the aid of your bank. Too many times, customers wait until there is a problem before they go to their bank for assistance, making it difficult for the bank to help. However, if the banker and the business owner have maintained a good relationship with open communication, the there will be no surprises on either side.
Alfred DeFlaviis is chief lending officer and senior vice president of First State Bank. Reach him at (586) 775-5000 or firstname.lastname@example.org.
Although bankers sounded a bit more optimistic about the commercial real estate market during the second quarter, more than half of the $1.4 trillion in commercial mortgages coming due nationwide in the next five years are underwater and many banks are refusing to renew the loans.
Owners who purchased property at the peak of the market in 2005 or 2006 face the biggest challenge, because commercial property values have since declined by almost 35 percent. Now, they must refinance to deal with looming balloon payments, but few owners can meet today’s stringent underwriting criteria.
“Roughly 90 percent of commercial mortgages require a balloon payment after five years,” says Vincent Shin, first vice president and manager of the South Regional Underwriting Center for Wilshire State Bank. “So owners may need to consider creative financing options to avoid a short sale or foreclosure.”
Smart Business spoke with Shin about refinancing options for commercial mortgage holders.
How has the underwriting criteria changed for commercial property loans?
Prior to 2008, banks considered the underlying equity when evaluating an application for a commercial property loan. Now they’re scrutinizing the underlying cash flow of the business for owner-occupied properties, at a time when many businesses are struggling to turn a profit. In fact, you could say that cash is king. And while bankers used to accept a debt service coverage ratio (DSCR) of 1.0, bankers now want a DSCR of 1.25. To give you an example of the impact, a business owner now needs monthly cash flow of $12,500 instead of $10,000 to qualify for a $10,000 loan payment. Compounding the problem, banks are requiring loan-to-value ratios ranging from 40 percent to 50 percent and high occupancy rates for tenant-occupied buildings.
How can business owners evaluate their situation?
Work with your CPA to determine your debt service ability, so you have a general idea whether you can qualify for a new loan. Do everything possible to boost your company’s cash flow or fill your building with quality tenants by granting temporary rent reductions or improving the property. Then, talk to the current note holder to gauge their appetite for refinancing your existing mortgage. Your current lender will know the state of the marketplace and the approximate value of your property and should help you find a solution to your problem, because the lender has the most to lose if you default or request a short sale.
What are the best refinancing options?
For owner-occupied buildings with outstanding loans of less than $2 million, an SBA loan is your best option. Owners of tenant-occupied buildings should shop around for a deal, because each bank has its own risk tolerance and loan portfolio that influence their desire and willingness to write new mortgages. Drive a hard bargain if your business is flush with cash and use a possible short sale or foreclosure as a bargaining chip to motivate your current lender.
What should owners do if they can’t refinance their commercial property loan?
Beyond a short sale or default, consider these options if you’re facing an upcoming balloon payment.
- Partial principal forgiveness. Some banks may be willing to reduce your loan principal to avoid a short sale or foreclosure.
- Second property. Consider mortgaging another piece of real estate with a lower loan-to-value ratio to pay off or reduce your current loan.
- Offer additional collateral. Sweeten the deal by pledging a second property or offering the bank additional assets or accounts.
- Bifurcated loan. Consider splitting the current loan into two parts and refinancing a smaller primary loan that satisfies the desired loan-to-value ratio. Then, finance the remaining indebtedness under a second deed of trust. For example, if the current property loan is $1.5 million, refinance $1 million through a traditional loan and immediately apply for a secondary loan to secure the remaining $500,000. The secondary loan will probably require a balloon payment down the road.
- Private equity. Refinance through a private equity loan.
- Add partners or investors. Consider bringing in an additional business partner or investor who could provide an injection of cash to reduce the loan principal.
- CRA loan. The Community Reinvestment Act (CRA) was enacted by Congress in 1977 to encourage federally insured banking institutions to help meet the credit needs of their communities, including those of lower-income areas. A building must be owner-occupied to qualify.
Do you have any other tips for business owners facing a balloon payment?
First, start the refinancing process at least six to 12 months before your balloon payment comes due so you can shop the market and improve your company’s cash flow. Use the ramp-up period to clean up your credit report, acquire new customers or tenants or sell an underperforming business unit. Author a business plan, sales forecast and personal profile, because prospective bankers want to see how you intend to pay for the loan. Finally, consider a variety of refinancing options. Owners need to be creative to survive in our current economy.
Vincent Shin is the first vice president and manager of the South Regional Underwriting Center for Wilshire State Bank. Reach him at email@example.com or (562) 345-3102.
More than 90 percent of American businesses are classified as small, but don’t under-estimate their power. Collectively, these enterprises employ more than half of all private sector workers, generate more than half our nonfarm gross domestic product and have created 64 percent of our economy’s net new jobs in the last 15 years.
In fact, the success of small business owners is so integral to the health of our overall economy that back in 1953 Congress created the U.S. Small Business Association (SBA) to serve as their personal advocate.
“The SBA offers owners a bounty of resources to help their small business grow,” says Anna Chung, senior vice president and SBA manager at Wilshire State Bank. “They not only help owners find funding, they’ll even help them write a business plan and navigate the lending process.”
Smart Business spoke with Chung about the opportunities to grow your small business through an SBA loan.
When should small business owners consider an SBA loan?
The SBA offers a number of financing programs to help small businesses grow. Established business owners usually apply for a 7(a) or a 504 loan. A 7(a) loan offers financial help for businesses in many different areas while a 504 loan provides long-term, fixed-rate financing to purchase major fixed assets for expansion or modernization. Although 504 loans can’t be used for operating capital, many owners use the funds to purchase a large building or second location, which helps free up money for expansion by allowing them to lease out the extra space. If you sign a large contract that requires purchasing additional inventory or equipment, call your banker right away so he or she can review your credit history and contract to see if you can finance the purchases with an SBA loan.
Do SBA loans offer better terms than other commercial loans?
An SBA loan is a standard commercial instrument that offers some very favorable terms. For example, the loans feature higher loan-to-value ratios, longer repayment periods and no balloon payments, yet still allow owners to partner with their local banker. Borrowers can purchase property by putting 10 percent down and pay back the loan over 25 years, which is better than most commercial mortgages. An SBA loan is ideal for growth as long as small business owners anticipate their future needs. Because if you wait too long to apply you could end up running out of cash, and owners need to show adequate working capital to qualify.
How does the SBA support banks in granting loans to small businesses?
SBA loans were designed to help small business owners who couldn’t qualify for a standard commercial loan, either because they have a smaller net worth or less working capital. So if an owner has access to other financing at reasonable terms he may not qualify for an SBA loan. The SBA guarantees up to 75 percent of the loan amount, which encourages a banker to lend, but the banker is responsible for meeting the SBA’s strict underwriting guidelines that are designed to mitigate risk.
How does the SBA qualification process differ from other commercial loans?
Owners still need to furnish a business plan, resume and copies of tax returns and financial statements, but these guidelines differ from standard commercial loans.
- Collateral. The loan must be collateralized if the borrower has collateral to offer, because the SBA requires bankers to mitigate risk whenever possible.
- Ownership. If the borrower owns several companies or controls several affiliates, lenders must review tax returns for those enterprises in addition to the owner’s primary concern.
- Down payment. Lenders must determine the source of a borrower’s down payment, even if the funds have been deposited into an escrow account. So owners need to provide documentation tracing the origin of a down payment.
- Tax returns. Owners must supply three years’ tax returns instead of two to qualify for an SBA loan.
- Criminal records and green cards. If a borrower has an arrest or conviction record the loan must be submitted to the SBA for approval. And an applicant’s green card must be validated by the INS before his or her loan is approved.
- Processing time. Most SBA loans are underwritten and approved in 30 to 45 days. But if the owner plans to purchase property, which requires an appraisal or an environmental impact report, the underwriting process may take 60 to 90 days.
Does the SBA offer other support to small business owners?
The SBA provides Small Business Development Centers (SBDCs) which offer owners free and confidential assistance with financial, marketing, production, organization, engineering and technical problems and feasibility studies. Many centers partner with local universities and engage local CPAs, retired executives and consultants to advise small business owners. In fact, the staff can even recommend a banker and help an owner develop a business plan or create a sales forecast to qualify for an SBA loan. The SBA also provides mentorships and free counseling services through a nonprofit organization called SCORE. SCORE has more than 389 chapters and 11,000 volunteers serving urban, suburban and rural areas. Keep in mind that the SBA also offers specialized assistance to women and veterans, so why not unleash the power of your small business advocate by visiting a local office.
Anna Chung is the senior vice president and SBA manager at Wilshire State Bank. Reach her at firstname.lastname@example.org or (213) 637-9742.
Before the financial meltdown in 2008, prospective home owners breezed through the lending process while pursuing the American dream. Now, even veteran borrowers can be stymied by today’s strict lending environment, especially if they rely on previous knowledge and experience to navigate the process. Fortunately, education, preparation and a little perseverance can help novices as well as seasoned borrowers surmount modern obstacles and realize their dreams.
“The pendulum has swung too far the other way and now lenders are looking for picture-perfect borrowers,” says Janette Mah, senior vice president and manager of the Residential Mortgage Group at Wilshire State Bank. “Borrowers can avoid frustration and disappointment by educating themselves on the underwriting process, meeting with lenders and securing pre-approval for a loan before they start shopping for a home.”
Smart Business spoke with Mah about the current mortgage climate and why borrowers need education and preparation to prevail.
How has the lending climate changed, especially in the greater L.A. area?
Lenders are being somewhat cautious because the economy and the housing market are sending mixed signals about their overall health. Unemployment is still very high, the economy is struggling and some areas in Southern California are still working through a backlog of foreclosed properties, which is keeping residential real estate prices from stabilizing. While the federal government will continue to play a role in securitizing long-term mortgages, the future of Freddie Mac and Fannie Mae is up in the air. After synthesizing all this information, it’s clear that homebuyers and lenders must approach the market with caution and diligently assess the risks before finalizing a transaction.
What should borrowers know about the current underwriting rules and mortgage qualification process?
Borrowers can no longer state their income; they must provide sufficient documentation to verify their earnings and assets in order to prove they can repay the loan. In addition, lenders are using a new set of standards to underwrite and evaluate risks, and while the requirements may differ for some programs including FHA loans, these are the general guidelines.
- Minimum credit score of 640 to 660 and a history of financial responsibility and saving. Borrowers can drive a better deal if their credit score is 740 or higher.
- Employment stability.
- Sufficient liquid assets to survive a temporary financial set back.
- Minimum down payment of 20 percent, and the funds must be in the borrower’s account for at least two to three months.
- Total monthly housing costs for principal and interest, taxes and insurance should not exceed 33 percent of gross income, while total monthly expenditures for all liabilities should not exceed 45 percent. Remember, even deferred payments on a student loan will count toward your monthly liabilities.
How can borrowers prepare for the lending process?
First, know your credit score by pulling a copy of your report and taking the time to clear up any issues before you approach a lender.
Second, research the various loan products to identify one that meets your needs. If you plan to stay in your home for more than seven years, then a 30-year or 15-year fixed rate mortgage might be the best choice, while a loan that offers a fixed rate for just five years might be appropriate if you plan to sell the property in a few years.
Third, study the lending process so you’re familiar with the paperwork and the requirements you’ll have to satisfy along the way.
Finally, calculate your income-to-debt ratio and research the real estate market, so you know how much money you need to buy a house and approximately how much you can borrow before you meet with a lender.
What’s the best way to approach a lender and avoid mortgage scams?
Contact two to three lenders to request face-to-face meetings and a quote. While it’s a good idea to survey the market by searching the Internet, borrowers generally get the best deal from a bank where they have an existing relationship. Vet the contenders by asking for their license number and searching for information on the licensing authority’s website. New legislation has granted consumers additional protection from fraud and scams following the crisis of 2008, so now mortgage originators are required to register and undergo a background check in order to comply with the Secure and Fair Enforcement for Mortgage Licensing Act (SAFE Act).
Total out-of-pocket costs for a 30-year fixed rate loan should average $1,500 to $3,000 and buyers should ask for a written estimate before agreeing to a deal. Lock in your interest rate for as long as possible so you can boldly tout your pre-approved status to realtors and sellers and negotiate with confidence when shopping for a home. Finally, remember to allow plenty of time when you finally locate the home of your dreams, because the underwriting and escrow process takes a minimum of 30 days.
Janette Mah is a senior vice president and manager of the Residential Mortgage Group at Wilshire State Bank. Reach her at (213) 427-1490 or email@example.com.