How to Invest in Commercial Property

Are you considering a commercial real estate investment?  The first thing to decide is whether you are looking for a safer investment (and lower return) or a riskier investment (potentially higher return).  If you are a first time or novice investor with limited experience, you should consider the former – a safer, less risky investment.  If you are an experienced investor, with lots of experience, you might be in a position to consider a riskier investment. 

What makes some investments safe and some risky?  The basic answer is property type, occupancy, and location.  Let’s consider each in turn.  First, we will discuss property type.  A multi-tenant, multi-use building is typically less risky than a single tenant special use property.  As an example, an apartment building with many diverse tenants is a pretty safe investment because if one tenant moves out, there is usually someone else ready to move in.  Apartment vacancy these days is at all time lows.  Contrast this to a single tenant property such as a bowling alley.  If the bowling alley operator can’t pay his rent and vacates the property, how long will it take to find a new tenant?  How much money must the landlord spend repositioning this property for a new occupant? The potential for vacancy and lost rent is very high.  Next, we consider current occupancy.  A good building with high occupancy performs better than a weak building with low occupancy.  The weaker building will probably need improvements or renovations in order to compete in the market.  An experienced buyer might prefer to take an older building that needs work and renovate the building in order to increase occupancy and rents.  Last, we consider property location.  The location is always key when discussing real estate.  Is the subject location in demand?  Is it near transportation and employment?  Is the area stable, up and coming, or past its prime?  Are people moving into the area or is the area losing popularity?  Understanding the location is key.

Before investing in commercial property, it is important to understand your risk tolerance level by analyzing the properly thoroughly upfront.  Your choice of investment should match your experience level, appetite for risk and expected return on investment.

If you would like to discuss a particular investment in greater detail, please call me 516-596-8537.  Good luck investing!

How to Invest in an Apartment Building

Stephen A. Sobin

As a commercial mortgage broker with almost 35 years of lending experience, I am often approached by first time investors who are looking to buy an apartment building as an investment.  These new investors want to understand the steps involved in locating and purchasing their first building.  The following guide should be followed:

Check Your Credit – go online to one of the free credit reporting sites on the internet and run your credit report and credit scores.  Lenders expect to see borrowers with a good credit rating.  If any negative items appear on your credit, make every effort to clear up these items in advance.  If you have experienced past problems, be ready to explain these problems in a well written letter of explanation.

Locate an Experienced and Competent Real Estate Agent – make sure you find a real estate agent that specializes in apartment buildings.  Most agents that sell homes for a living have no experience selling apartment properties.  As a first timer, you need an agent that can help you through the details, as a commercial investment is much different than buying a home.  The agent should understand which neighborhoods are on the rise and which neighborhoods to avoid.

Get Full Disclosure – it is crucial that you obtain complete financial records on the property.  Do not rely on verbal statements.  You need to verify all income by looking at the leases and all expenses by looking at actual bills.  Most sellers overstate the income and understate the expenses.  Do your homework carefully.

Visit the Property – do not consider making an offer until you inspect the interior and exterior of the property carefully.  Is the property in good repair?  Is there any deferred maintenance?  Are the units actually occupied or is there apparent vacancy?  Is the neighborhood relatively safe and free of crime?  Are there other buildings in the nearby area that are in disrepair or suffering from high vacancy?

Make a Legitimate Offer – don’t be fooled by a high asking price.  Calculate the gross income and subtract expenses to come up with a net operating income.  The NOI needs to be adequate to cover a proposed mortgage, as well as, return a profit to the owner.  If the numbers don’t work, keep shopping.

Engage an Experienced Commercial Mortgage Broker – a commercial mortgage broker specializes in financing investment properties and will understand all of the nuances of a commercial mortgage loan.  It is crucial that you find a broker who is competent and experienced.  As a first-time buyer, the advice you receive will be invaluable.  A good broker will make sure you offer a fair price and do not overpay.  He will understand the market and negotiate the best terms available for your particular needs.

Be Prepared to Move On – many investment opportunities are not fairly priced.  Do not make the mistake of falling in love with a property.  This is an investment and you need to remember that the goal is to make a profit.  If the property does not make sense, move on and keep shopping.  Your commercial mortgage broker will assist you in this regard.

What are CAP rates (and why should I care)?

Commercial real estate owners and buyers are always confronted with the same question: “How do I determine the value of a commercial real estate property?”  Homeowners and homebuyers rely on the market data approach which simply looks at comparable sales in the market to determine value.  Commercial properties rely more heavily on the income approach or the income capitalization method to determining value.  The income approach requires an understanding of CAP rates or capitalization rates.

In order to begin the analysis, we need to determine the net operating income of the subject property.  The NOI is defined as the net cash flow of the property and is determined by taking the gross income and subtracting the operating expenses.  Gross income includes rents, common charges, parking income, and all other income sources.  Operating expenses are all of the costs associated with running the property, and include: vacancy allowance, management fees, real estate taxes, utilities, repairs and maintenance, etc.  The bottom line figure is the net operating income or net cash flow.  This NOI figure is what we will use to determine property value.

Investors have many options when it comes to investing their money.  They could deposit their funds in a bank account and these days earn 1-2% return on their money.  They could buy stocks and bonds with the hope of earning higher (but uncertain) returns.  Many choose to invest in real estate instead.  Let’s say an investor wants to earn a 5% return on his money and buys a property that generates annual NOI of $50,000.  That 5% return on investment is defined as the CAP rate.  In this case, the property would need to sell for $1,000,000 to yield $50,000/year at 5% return ($1,000,000 times 5% equals $50,000.  If the investor demanded a 6% return on his investment, the property would need to sell for $833,333 ($833,333 times 6% equals $50,000).  From this basic example you can see that a property value will change based on the rate that an investor will expect to earn on his investment.  In times when bank interest rates are high, real estate prices generally go down, as investors will expect to earn returns that exceed bank deposits.  When bank interest rates are low, real estate prices typically increase, as investors are willing to earn a lower return on their real estate investments.

Since September 2018, we have been seeing an increase in market interest rates.  If this continues and rates continue to rise, we could expect to see downward pressure on commercial real estate prices.

What to watch out for when considering a commercial property investment and what the “hot buttons” are for commercial mortgage lenders

I constantly receive phone calls and emails from borrowers who ask me what to watch out for when considering a commercial property investment and what the “hot buttons” are for commercial mortgage lenders.  Here are some thoughts:

Borrower

These days, lenders look very closely at the borrower’s qualifications before extending credit.  The borrower should have good credit, with FICO scores of 680 and higher.  Lower credit scores may be acceptable with solid, written explanations.  If your credit contains any foreclosures, bankruptcies, judgements or short sales, be prepared to offer full disclosure upfront and have proof that everything has been settled.  Next, lenders will look at the borrower’s total net worth and liquidity.  They will expect to see a financial statement with net worth equal to the loan amount and at least six months of cash reserves to cover debt service.  If a borrower expects a commercial mortgage loan of $1,000,000 or more, they have to show the lender that they have the financial statement to back up the loan.  Equally important to the lender is experience.  Do you have experience owning and/or managing similar properties?  If not, are you willing to hire a professional management company to manage the property for you?  Lenders need to secure their investment and will not lend to a borrower that does not have a proven track record.  Last, a lender will look at the size of your down payment.  Gone are the days when banks and other lenders will offer 100% financing or other very low down payment loans.  Lenders will expect to see a owner that is vested in the project.

Property

Next, a lender will look at the property.  They will expect to see a well run property in good condition.  They will look at the demographics of the neighborhood and local crime statistics.  Properties that are run down, poorly managed, or in very rural areas will be highly scrutinized.  These properties might require a short term bridge loan or private money loan until they will qualify for regular bank financing.  Another very important factor to consider is the past and current use of the property.  Properties that are, or could be, environmentally hazardous will require extensive environmental testing.  Properties like gas stations, dry cleaners, and industrial properties with onsite chemicals will be very hard to finance.  These days, retail properties with marijuana based tenants will almost certainly cause problems for a lender.  It is very important for a lender to review the tenant base and the types of businesses located at the property upfront.

Financial Numbers

After a lender is comfortable with the borrower and the property type, they will then delve into the numbers.  First, they will look at the rent roll to make sure that the vacancy and rental rates are acceptable.  They will look at how long the tenants have been in occupancy and how long the leases are.  Properties with constant turnover and poor leases will cause problems for a lender.  Next, a lender will look at 2-3 years of operating statements and look at the income, expenses, and net cash flow.  They will expect to see properties that have a proven ability to generate rental income, reasonable expense ratios, and net income that is sufficient to cover the mortgage payments.  They will calculate loan-to-value ratios, debt service coverage ratios, and debt yields.  Lenders have internal guidelines for all of these calculations that must be met.

Banks and other lenders got into lots of trouble during the last recession by making credit decisions too freely and without proper oversight.  Lenders today are required to be more careful so as to avoid the problems they encountered in the past.  At Select Commercial, we are well versed in preparing loan packages that make sense and address lenders’ concerns.  Let us know if we can help you!

Select Commercial Specializes in Small Balance Apartment Loans

Select Commercial Funding LLC is an apartment lending specialist in the origination of small balance apartment loans from $1,000,000 to $5,000,000.  We proudly originate loans nationwide and offer extremely competitive rates and terms.  Some of the features and benefits of our program include:

Lending Areas

Many lenders only wish to lend in large, urban areas within well populated cities.  Our program covers the entire country.  We lend in large markets, small markets, and even rural areas.  Most national lenders do not feel comfortable going into smaller markets with lower population densities.  We are well equipped to handle these requests.

Loan Terms

Most local banks prefer to lend short term, usually offering rates fixed for only 5 years at a time.  We offer fixed rates for five, seven and ten year terms.  In addition, we will amortize our loans for up to 30 years and often offer interest-only periods as well.  Local banks often amortize their loans for a maximum of 20 or 25 years which increases the monthly payments and negatively affects the property’s cash flow.  It is also very rare for a local bank to offer an interest-only loan.  Another huge benefit of our program is that we offer a hybrid/adjustable option.  After the initial five, seven, or ten year fixed rate period, we can convert the loan into an adjustable.  This option eliminates the balloon payment due at the end of the initial fixed rate period.

Loan-to-Value Ratio

Whereas most local banks will limit their LTV ratio to 70% or 75% maximum, we will consider requests up to 80% LTV.  On a purchase transaction, a lower down payment means a larger purchase and less cash tied up in the process.

Personal Guarantees

Almost all local banks require that the borrower sign a personal guarantee.  A huge benefit of our program is that we offer Non-Recourse financing (subject to standard carve-outs).  This allows companies, entities, investor groups and multiple parties to purchase a property without having to have every member sign personally.

Pre-Payment Penalties

Whereas many national lenders charge yield maintenance penalties which create huge penalties in the event of a sale or refinance, we offer easy stepdown penalties.  These penalties greatly reduce the cost if you decide to sell or refinance the property at a later date.  And, our loans are assumable.  If you do decide to sell, a qualified buyer can assume your loan at very attractive terms.

Documentation Requests

Another huge benefit of our program is that we do NOT require personal or corporate tax returns.  We will underwrite your loan using a rent roll and historical operating statements.  Our underwriting is common sense and fast.  We close most of our loans within 30-45 days from formal application.

 

Rate Locks

We do not charge an additional fee to lock your rate.  We automatically lock your rate for 35 business days from signup at no additional cost.  This gives us plenty of time to close your loan and offers you the protection against rate increases from signup to closing.

Low Third Party Costs

Other lenders collect very high upfront fees for third party costs, including: appraisal, environmental, engineering, credit, processing, legal, etc.  We offer a capped cost option.  We collect one smaller amount (as low as $5,000 total) and cover ALL third-party costs with that deposit.  This alone can save you thousands of dollars of processing and closing costs.

 

It is very simple to begin our process.  We will discuss your transaction with you upfront to determine if you and your property will qualify.  If you would like to discuss a potential transaction with us, please call our office at 516-596-8537.  You may visit our website at www.selectcommercial.com for more details.

 

How We Help Our Customers

Select Commercial specializes in commercial mortgage loans from $750,000 to $10 million and we lend nationwide.  Many people ask us why they should choose Select Commercial rather than their local bank.  In addition to great rates and terms, fast turnaround time and superior service, we have the ability to close loans that banks and other institutions often find difficult.  Here are some examples of loans that we have closed recently:

Albuquerque, New Mexico – our borrower owned an office/retail property with tenants that all had short term leases.  The borrower’s current bank was concerned that the tenants would not renew and the property would become vacant.  We were able to offer this borrower a 5 year fixed rate loan with a 5 year renewal option and a 25 year amortization.

Cape Coral, Florida – our borrower owned a small apartment complex in a small market.  The borrower lived in New York and local banks were uncomfortable lending to an out of state borrower.  We had no difficulty with this transaction.  We approved a refinance of a high rate loan and provided cash out as well for property improvements.

Brooklyn, New York – our borrower was looking to refinance a small apartment building, but had slow credit.  The local bank did not like the borrower’s credit score.  We liked the property and did not allow credit to get in the way of our approval.

Bensenville, Illinois – our borrower was purchasing an apartment complex and needed to close within 45 days.  His current bank could not work under that timing constraint.  We had no trouble closing quickly.

Byron, Georgia – our borrower owned a mobile home park and was looking for a 30 year fixed rate loan.  His local bank would only fix the rate for 5 years at a time.  We made a 30 year fixed rate loan at a great low rate.

Whatever your needs, Select Commercial has a loan program to suit your individual needs.  If you would like to review a loan scenario with us, please contact us today at 1-877-548-9454.

What Makes Us Different?

We often have people ask us why they should apply to Select Commercial rather than just going to their local bank for a commercial mortgage loan. Banks typically have one set of guidelines, and if your loan does not meet their guidelines they will probably not be able to accommodate your request. At Select Commercial, we have numerous loan programs to choose from and attempt to custom tailor a commercial mortgage loan that meets your individual needs. Many, if not most, of our successful loan approvals required us to overcome an obstacle that other lenders were not willing to do.

I would like to review a few of these situations that have recently been approved:

  • Our borrower owns an apartment property in Lowell Massachusetts. He was looking to refinance a high rate loan and obtain cash for property improvements. The property was older and needed renovation. The current property condition made the borrower’s bank nervous. We approved this loan at a rate that was lower than the bank. We also offered a long term fixed-rate loan and a long-term amortization. The term was also longer than the bank was offering.
  • An owner of a mixed-use property in Chicago Illinois approached us about refinancing his property. The owner had credit and income problems which his bank could not overcome. The borrower was also looking to minimize his monthly payment and was requesting an interest only loan. We were able to accommodate this borrower at a very attractive rate.
  • A co-op Corporation in New York City was looking to refinance the underlying loan on the cooperative building. Their current loan did not mature for six months and they did not want to pay a prepayment penalty. They were concerned that rates would rise if they waited for six months. We approved their loan and gave them an extended rate lock for six months. In addition, our rates and closing costs were lower than they could obtain on their own.
  • A borrower in Cleburne Texas owns a small un-flagged motel. They needed to pay off the seller who had taken back a mortgage upon purchase. Most lenders do not like loans in small towns and do not lend on motels that are not part of a major chain. We were able to prove this loan without a problem.
  • Another client of ours owns a student housing property in Gainesville Florida. They needed to refinance a very high rate loan and obtain cash to buy out partner. The former partner mismanaged the property resulting in lower than necessary income needed to qualify. We were able to look at pro forma income and approve a loan based on projections.

Most commercial mortgage transactions require that a lender be willing to listen to the story and try to find a way to overlook the negatives associated with the deal. Good lenders will look for a reason to approve a loan, instead of saying “NO”. At Select Commercial, we are constantly looking to find a way to approve his many loans as we can. Please contact us if you would like to discuss a commercial mortgage loan transaction with us.

Interest Rates Expected to Rise

The Federal Reserve is expected to start raising interest rates as the labor market tightens.  According to reports, these rate hikes could start as early as September.  Please see the following article from yesterday’s New York Times: http://www.nytimes.com/2015/07/30/business/economy/federal-reserve-meeting-interest-rates.html

Why Should I Use Select Commercial?

Many of our customers have asked us why they should use Select Commercial instead of just going to their local bank to obtain a commercial mortgage loan. Select Commercial has the ability to close loans that other lending institutions can not close. Since we have numerous sources of capital available to us, we can offer better commercial mortgage terms than most other individual lenders.
We would like to share some examples with you:

1) One of our recent clients was looking to purchase an apartment building in Oklahoma. The client lived out of state. Their local bank would not approve this transaction. We approved and closed this deal and at a lower rate than their bank was charging for local customers! We lend nationwide and the fact that the borrower lived out of state did not concern us.

2) Another one of our clients owned a retail strip center in New York. He was looking to buy out his partner and needed cash. His local bank did not offer cash out refinances. We allowed him to cash out over $1,000,000 to help him acquire the property from his partner, and we offered a great rate as well.

3) We recently had a client in Colorado that owned and operated a restaurant. His current rate was very high. He wanted to lower his rate and withdraw cash to open a second location. His local banks were not interested in making loans to restaurants, and certainly could not offer cash out. We had no problem with either of these situations and closed the loan.

4) Another client was looking to purchase a trailer park in Maryland. This was his first property of this type and the location was somewhat remote. None of his local banks wanted to make this loan. Again, we were fine with this transaction and we closed this transaction with no hesitation.

5) We currently have a client looking to refinance a New York City co-operative mortgage loan. Their current loan matures in 2016 but they want to lock in today’s low rates. We offered them an extended rate lock option, allowing them to apply early, lock in the rate now, and close next year!

These are just a few examples of commercial mortgage transactions that we have offered our clients recently. If you would like to discuss a scenario, please call us today at 516-596-8537 or click here for a free quote.

Federal Reserve Announces Likely Rate Hikes

Since the economic crisis and financial meltdown in 2008, the Federal Reserve has kept the Fed Funds rate at very close to zero. The Fed Funds rate is the rate that the Federal Reserve charges to its member institutions. By keeping this rate very low, banks and other financial institutions have been able to keep the interest rates they charge to their customers at historically low rates. This has allowed individuals to buy homes, cars and other large items at very low rates – stimulating an economic recovery. Business customers and commercial real estate owners have likewise been able to buy and refinance commercial property at historically low rates. Most consumer and business loan rates are tied into the rates in the United States treasury market. Since the Fed funds rate has been so low, United States treasury securities have also been very low for the past seven years.

The Federal Reserve is starting to reassess their strategy and have announced that it is likely that rates will begin to rise between now and the end of this year. An increase from the Federal Reserve will cause an increase in the United States treasuries, which in turn will mean an increase in the rates charged to consumers and business owners. For more information on likely policy from the Federal Reserve, click this Washington Post article.

If you are considering purchasing a new commercial property, investment property, or refinancing the debt on your existing commercial mortgage loan, you should consider acting now before rates increase. For more information, please contact us at 1-877-548-9454 or visit our website at www.selectcommercial.com.