I constantly receive phone calls and emails from borrowers who ask me what to expect when approaching a commercial real estate lender for a commercial real estate loan. Here are some thoughts to consider:
These days, commercial real estate 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 the borrower’s credit contains any foreclosures, bankruptcies, judgements or short sales, he must 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 real estate loan of $1,000,000 or more, he will have to show the lender that he has the financial statement to back up the loan. Equally important to the lender is experience. Does the borrower have experience owning and/or managing similar properties? If not, is the borrower willing to hire a professional management company to manage the property for him? Lenders need to secure their commercial real estate loan and will not lend to a borrower that does not have a proven track record. Last, a lender will look at the size of the 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 an owner that is vested in the project.
Next, a lender will look at the property securing the commercial real estate loan. 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 a commercial real estate loan with a traditional bank. 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 commercial real estate lender. It is very important for a lender to review the tenant base and the types of businesses located at the property before approving a commercial real estate loan.
After a commercial real estate 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 before approving a commercial real estate loan.
Banks and other commercial real estate 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!