Banks are taking a hard look at their lending practices, and that is making it more difficult for owners of commercial properties to get loans. As loan requirements are tightened and banks remain skittish, property owners will have to work harder to prove they can repay a loan, says Rocco Pirrotta, senior vice president and Commercial Real Estate group manager at Wilshire State Bank.
“The days of property owners being able to refinance every few years and pull some money out of their properties are over,” says Pirrotta. “Borrowers are facing a new reality. Banks expect them to be more familiar with their properties, are reducing their loan to value rates and taking a closer look at finances.”
Smart Business spoke with Pirrotta about how banks’ lending practices are changing and what commercial real estate owners can do to improve their chances of being approved.
How have banks’ approaches to loans changed?
For the past three years, banks have been working on fixing bad loans, restructuring loans and addressing foreclosures. As the market starts to get better in most areas, it’s going to be a difficult transition for banks to put their production hats back on.
Banks are cautious. They don’t want to make the same mistakes that got them into this problem: overleveraging properties, buying into continually increasing values and low cap rates on property, and getting outside of their comfort zones with respect to property types in order to grow their portfolios.
It’s easy after spending three years liquidating and collecting on bad debt to never want to make another loan again, so they are going to be walking a tightrope trying to balance between growing their portfolios but not growing too fast and not falling into the same traps.
How will these changes impact commercial property owners?
It’s a new reality. You’re going to see lower loan to value. In the past, banks traditionally did 75 to 80 percent loan to value on many property types. Now, you’re going to see 60 to 65 percent. That means borrowers are going to have to come up with more money down for purchase transactions, they will not be able to get as much cash out of refinancing existing properties and they’re going to have to find banks that have niche markets for certain property types. Mainstream banks will stay focused on industrial, retail, apartments and office buildings. Banks that will finance car washes, hotels, gas stations, land deals, etc., are going to be few and far between.
That will be offset with lower interest rates prevailing and remaining steady, and owners will be able to refinance existing projects in the four major areas at better interest rates than they have been able to for years.
What kinds of things will banks consider when making real estate loans?
In this latest recession, short-term leases with tenants on retail and office products became prevalent because, during a down time, owners don’t want to sign someone to a long-term lease at a low rental rate because they anticipate things will get better. As a result, many of their leases will be coming up at the same time. Owners are going to have to combat that with the bank by providing operating numbers from tenants to show that the existing tenants are viable and that they can maintain those leases.
More banks will be asking not just for rent rolls but also for accounts payable agings so they can see how much rent is actually being paid. In the last few years, many landlords have made concessions to tenants; while the lease may say the tenant is supposed to pay $2,000 a month, the landlord may only be collecting $1,200 to keep the tenant, so the bank will want proof.
Owners are also going to have to dig a little deeper and come up with better forecasting. How many of the current tenants are going to stay, and why? Can you increase the rent on those tenants, and if you think you can, why? Banks are looking for a more comprehensive understanding of what is actually being collected.
What else are banks looking at?
The condition of the properties is going to be critical, because during down times, people often don’t take care of the maintenance and only do the bare minimum. Now, as markets begin to get better and more financial institutions are getting into the lending game, they’re going to be pickier and want to make sure the property is well maintained and that there aren’t significant deferred maintenance issues.
Before making a loan, loan officers are inspecting the property, and it’s not just driving by and taking a few pictures. It’s meeting with the owner at the property and going through units and asking questions, such as when the roof was last repaired. It’s talking with tenants, asking what they think of the condition of the property. Is the landlord taking care of the property for you? Are you willing to stay? Banks are going to be a lot more involved in the underwriting and functionality of the properties.
They’re also going to be taking a closer look at secondary support. If the property value goes down, or if you lose tenants, does the borrower have sufficient strength to supplement payment of the loan for a period of time?
The bottom line is that financial institutions need to be more disciplined about lending practices and stay that way, and borrowers need to be more realistic about values and leverage of their property.
Rocco Pirrotta is senior vice president and Commercial Real Estate group manager at Wilshire State Bank. Reach him at Roccopirrotta@wilshirebank.com or (213) 427-6592.