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:
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.
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.
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!