Top five reasons why your commercial property has not been approved:
1) Value. Commercial properties are valued based upon their ability to produce income. Many if not most commercial properties have been faced with declining occupancy, and declining rental rates per square foot as tenants demand better value for their rental income. Issues such as these have a direct bearing on the value of your property, and are the major cause for declining commercial property values around the country. Meanwhile, more and more banks want to lend at a 65% loan to value.
Solution: Bay Area Capital Funding Inc. has access to non-traditional lending sources, including pension and hedge funds, which will allow in many cases a loan to value of up to 80%, even on a commercial investment property.
2) Debt Service Coverage Ratio, a commonly used underwriting criterion, can be calculated as net operating income divided by the debt obligation payments; either a monthly or yearly expression is acceptable. For the same reasons as described in #1 above, net operating income has been under pressure (due to increased vacancy and declining rent income). Since DSCR is based upon NOI / debt service; this means that in many cases DSCR is declining as well. Banks are looking for DSCR of 1.25, at a minimum….some want 1.35 or even 1.45 DSCR.
Solution: Bay Area Capital Funding Inc. has access to non-traditional lending sources, including pension and hedge funds, which will allow in many cases a DSCR of as little as 1.00, even on a commercial investment property……although keep in mind that rates and terms are better for properties that can demonstrate a more reasonable 1.15 to 1.20 DSCR.
3) Property Condition. This nebulous and highly subjective characteristic is a very useful “copout” for many banks in our current market. The thing is, is that banks of course can set their own internal standards for property condition. It is the inconsistent application of these standards that I find highly irritating. Many banks are looking for, and lending on only properties that are not only nice to look at but are in pristine condition with no deferred maintenance issues.
Solution: Bay Area Capital Funding Inc. has access to niche lending sources, including pension and hedge funds, and certain banks that are actually seeking less than perfect properties...at a slightly higher yield of course. Recent closings include an apartment in a very difficult portion of Oakland California and in the Sacramento Valley area as well. The key is an up to date understanding of which bank will like which property.
4) Lack of Historical Documentation: It is not uncommon with properties that have gone through foreclosure, or bank repossession and resale, for there to be no historical operating statements, no historical rent rolls or vacancy numbers, and no historical expenses. Most banks will decline a property such as this without going any further; they simply cannot accept the risk of a property with unknown expenses.
Solution: Bay Area Capital Funding Inc. has access to certain niche and financial lending sources, which will allow in many cases a loan to move into underwriting on the basis of estimated expenses and NOI….these numbers will need to be reasonable and eventually verified (or slightly amended) by the appraisal process.
5) Unfinished / Unrentable / incomplete Property: Most banks and lenders will expect and require your property to be not only complete, but functioning, with tenants and low vacancy, and several years of operating history. Banks have very little interest in anything that they consider “speculative”, and most banks would consider an incomplete property to be “speculative” not just because of the construction perspective, but doubly so because of the unknown income and expense numbers for the property as well.
Solution: Bay Area Capital Funding Inc. has access to non-traditional lending sources such as niche banks and pension funds that accept (and even seek out) rehab and construction projects, often with loan funds not just for purchase and / or the refinance of existing debt, but often with additional funds advanced (or set aside) for the rehab or completion of the project as well. A heavy reliance on the appraisal for estimated costs, estimated income, and estimated expenses are of course standard in this instance.
Just in the last few weeks I have begun working with a new lending entity that fills an enormous niche. As you know, banks are lending to only the top 10-15% of all commercial properties nationwide. They (the banks) site a myriad of reasons for not lending, but it is usually one or more of the following issues that cause a decline from a bank:
This new loan program, which I plan to market very heavily, is more flexible in almost every respect. The pricing also falls between hard money and bank money with rates from the sevens to the high eights, and points priced likewise between 2 -3 total.
Among other things, this lending program allows:
This is a very exciting new program that should work well for a large number of commercial properties that are just missing bank financing terms. Avoids the 10-11% rates of hard money and the hard money costs of 4-6 points.
This past weekend I was thinking a great deal about private money - also known as hard money. I am always reluctant to put a client into a hard money loan; despite that, at BACF Inc., hard money lending is growing faster than any other segment of our business. Of course, this is merely a reflection of the banking industry being unwilling to lend. Now, "unwilling to lend" is a harsh term of course and all the banks can dredge up statistics to show that they are in fact lending. The problem is that really that they are lending under such strict guidelines that a large segment of market demand - both for residential and commercial lending - has no where to go. There are simply no programs available for those individuals with tarnished credit, insufficient or non-verifiable income, past bankruptcy or foreclosure, or issues related to asset verification, income or job history, or credit history. On the commercial side, programs and guidelines have also tightened, property values have declined, and in some cases vacancy has risen, or rent incomes have declined; as a result of this there has been an enormous vacuum created and many commercial properties are searching for a source for any possible source for refinance funding. For example, debt service coverage ratios, which in the pre-meltdown world of lending were accepted in the range of 1.1 - 1.3; are now in the post-meltdown world expected to be 1.25 as a general minimum and in some cases we see guidelines requiring DSCR of 1.4 to 1.45, at a minimum. Likewise most of the big banks now expect an LTV of 65% at the most (we know of a couple banks that will still allow up to 80%). As a bank, if you require a DSCR of 1.35 and will lend at 65% of market value, then you know very well that you are excluding as much as 75% of the commercial paper from refinance. You are "cherry picking" loans of unquestioned value. You are protecting your shareholders, and yes you are protecting your own job as a bank officer but I believe it is a stretch to claim that this is serving any great need in your community. Because the need is there.
Anyway, all of this commercial and residential lending that should be going to banks is falling into the hands of private lenders and hard money loans. BACF Inc does a number of hard money loans every month; primarily in San Mateo and San Francisco and Santa Clara counties, but also a growing number of these loans in Marin, Alameda and Contra Costa County as well. I define a hard money loan as any loan that is at least four percentage points higher in either rate or fee, than what the same loan would be from a bank. They are expensive, but what is the alternative if you need a loan?
The biggest controversy right now with hard money loans is related to their use and appropriateness for owner occupied residence loans. Residential owner occupied loans are afforded much greater protection for the consumer. Both RESPA and HOEPA regulations make it very difficult for consumers to refinance their owner occupied properties using hard money; likewise an unwary lender has great liability in creating a hard money loan for an owner occupied residence without a great deal of care, caution, and extra paperwork of course.
As a consumer, it is important to be cautious when applying for a hard money loan. I have certainly heard of many hard money loans in my day that were - in my opinion - more expensive than they should of been. In most cases the lender or investor should be charging no more than four points, and a broker such as BACF should be charging one to two points, at the most. Most of our transactions involve less than six points, but typically more than four points. in most cases, there is no need to pay more than six points. Recall a point is 1% of the loan amount.
Rates for hard money loans are typically more than 10%; in some cases however for very strong files we see rates in the mid-nines. A typical rate will range between 10.25% and 11.50%. To me, the points are more important than the rate since the private loan is hopefully a bridge loan of sorts to move you from a difficult situation into (we hope) a situation where we can assist with an eventual refinance into a more conventional loan - residential or commercial - with rates at a more market appropriate level.
Watch for prepayment penalties with hard money loans also. We see a wide variation of lender expectations for prepayment penalties. Obviously, if you have a three year loan term and a three year prepayment penalty then there is something wrong. Avoid defeasance fees; avoid yield maintenance agreements, and try to avoid any prepayment penalty that exceeds 2% of the loan balance as a penalty. The lenders we work with will in most cases either waive a prepayment penalty completely or add a simple interest guarantee for six to twelve months.
Most private mortgage lenders will not require much in the way of income documentation, and they will not care much about your credit. But private mortgage companies are all different and in my opinion finding the right private lender is the most critical part of the equation. We have had some clients who just barely miss qualifying for a bank loan...there are special private lenders for these situations. Often, the companies (private lenders) with the best rates and fees will ask you to provide full income and asset verification, and expect you to have at least decent credit. But if you qualify you could find yourself with a rate in the nines and maybe three points paid.
For example, we had a client recently who was an "A Paper" (bank) candidate in every way, with the exception that he was buying a bank owned property, so he needed a quick process, and in addition he was using an unrelated second property of his as collateral. Banks are reluctant to cross collateralize, and in our current market, they do not move quickly....for this reason, we needed to involve one of our private money lenders. For now, his loan is approved and ready to go while he continues to search for the right property. In the end, he will acquire a property that is worth about $425,000 for a price of about $230,000 to $240,000. In his mind, the extra cost of the loan is incidental compared to the savings he will make by buying the property at such a discount.
A common misconception about hard money loans is that they will allow a small down payment. This is not the case; hard money is relaxed about most issues but equity and down payment are not on that list. Hard money lenders can work with an LTV of up to 65%; however in some cases I have seen recently private lenders have offered loans at LTV's as low as 45% of current market value. If your situation is complicated in any way, you should expect an LTV of about 50 or 55%.
The value of a mortgage broker was proven to me again last month when we were approached by a client who owns a large apartment building in San Mateo County.
This client has a first and a second loan on the property, and had approached several banks to assist with his refinance. All of these banks (Citi, Chase and Wells as I recall) felt that his loan size was too large compared to his property value (loan to value in other words) and were concerned about his ability to debt service (debt service coverage ratio) the new loan.
I love loans like this. First of all, the client understands at this point that his situation has some challenges. Secondly, however, it gives me a chance to demonstrate my knowledge of the local market and local lenders and - at the same time - justify my role in the eyes of the client.
Because the commercial lending market has gone through so many changes, a knowledgeable mortgage broker can make an enormous difference in a transaction. Every commercial loan lender makes their own rules. Each bank, and every lender has their own strengths and weaknesses, their niches, and their own target markets.
After putting the client's apartment building through a thorough analysis, I was convinced that I knew of one local San Francisco Bay Area bank that would work with their situation. This is a bank that emphasizes cash flow, and global cash flow, and debt coverage, but cares less about LTV and less about the age and condition of the property. (I have had actually had banks say "no interest" in loans - after looking only at photos...).
Fortunately, this bank was a perfect fit for this client. The loan is approved and I expect the file to close in the next few weeks. The savings in interest expense alone will save the client many thousands of dollars every year.
We took a situation where the client was seriously concerned about the profitability of the property - his interest payments, especially on the second loan, were extremely high. When completed, this property will perform like a race horse and spin off nice cash flow for many years to come.
So the client is now a big fan of this Bay Area bank, and showed some interest in taking another large commercial building that he owns to this same lender.
Interestingly, however this building has a completely different profile. This same bank would do the loan, but so would many of the other banks and lenders that I work with. We work with several credit unions and insurance companies, and in my opinion this other larger San Francisco commercial building would qualify for loans at lenders that offer even lower interest rates.
Which proves my point once again; there is no such thing as a "go to" bank. Each property, each building, each client, need to be carefully analyzed and matched with the right lender for their situation. A good mortgage broker brings not only the ability to package and present your property in the best possible light; but also the knowledge of who to present the package to....insurance company, credit union, local bank, regional bank - they all have their strengths and comfort zones.
I was thinking the other day about the role of the mortgage broker, in this new world where banks seem to rule supreme, and where they make their own rules about how and when they decide to lend (or not lend) and work (or not work) with mortgage brokers.
Mortgage brokers, it seems to me, bore a large share of the blame for the financial meltdown, and I have never been comfortable with this characterization. Having been in the business almost twenty years now, I can say with confidence that the vast majority of all mortgage brokers I have known were honest and hard working Americans.
The lending products sold during the crazy years from 1995 through 2005 or so were all products designed on Wall Street. The big banks, including Washington Mutual and World Savings, and countless others, came to the mortgage broker community with these products and provided training and support to sell the products designed by executives at the highest levels of these companies.
Their products included no-income verification, no asset verification, light-doc and no-doc and 100% financing loan programs of just about every shape size and color. After some of these meetings I remember talking with my associates about how crazy it seemed to be offering loan products to individuals who could not really demonstrate reasonable credit or income, or source their assets and down payments. But most of the lenders were offering these products, and who were we (we would think) to question the product skills of these highly paid executives, and their knowledge of the secondary mortgage markets, where mortgage backed securities were bundled and sold?
We all knew that regulators were in place. We all knew that there were ratings companies; highly respected companies like Standard and Poors and Moodys that would rate the risk and salability of mortgage backed securities.....surely if these reputable companies were "in support" of these products, then who were we to question the wisdom of these products?
There was no mortgage broker on the planet with the power and authority to file a complaint. A boycott of these products was pointless; clients would just flow to competitors. Simply put, there was nothing any mortgage broker could have done to slow or prevent the financial meltdown.
I don't mean to say that there were no abuses, and that every mortgage broker was a saint...this was absolutely not the case. There were (and still are) mortgage brokers who should not be allowed to practice. But to blame mortgage brokers for the financial meltdown would be like blaming your bank teller for high ATM fees. The blame does not rest with those who came into contact with the public....they were doing what they were trained to do. The blame should go straight to the top where these decisions were made.
Regrettably, there have been very few corporate executives who have taken any heat whatsoever for their actions. Despite profiting at the expense of the general public, most of these executives exist today and continue to be overcompensated. They basically "raped" the country and got away with it.
The political parties rely too much on campaign contributions to pursue legal action against these executives, so there is almost no chance that they will face the consequences of their behavior.
Often I receive calls from clients asking for stated income commercial loan programs. Few people outside of the commercial mortgage business really understand what this means.
In years past, when loan guidelines were looser, "stated" programs often really meant "light doc", with limited personal client income documentation. These programs have completely disappeared from the mainstream commercial landscape. To find a stated income program in this market, we need to look into private and hard money lending.
Note however that current stated income programs are not truly stated income, in that a full income analysis of the building is always required. Rent rolls, operating statements, current and past years income and expense statements, leases - these are all required. Hard money "stated income" loans may not require personal tax returns, W2's, paystubs, etc....but there are no loan programs in commercial lending that will not require complete understanding of the income performance of the property in question.
In recent months more and more hard money and private money lenders have been pulling back and increasing their requirements for full documentation. Basically, with enormous demand for hard and private money, these lenders are becoming selective and not lending on many transactions that they would have funded in the past. Hard money lenders have been moving fast to manage their risks, and most will want a fully documented loan package.
Hard money lenders have moved into the realm formerly occupied by banks and commercial mortgage backed securities. With a high percentage of commercial bank loan fallout, the need for hard money has been tremendous. Most lenders - even hard money - are even more concerned about cash flow and and debt service than they are about value and equity.
The message here is to not expect too much from stated programs in today's tight lending market. Be prepared to provide full client financial data, and a complete characterization of the property from a financial perspective; both current and historical. Anything less than this will be extremely expensive.
I seem to get a high number of phone calls about how much personal income it takes to qualify for a commercial mortgage. The correct answer is; not neccessarily very much. Last year I closed a two unit project on the coast where the upstairs was an apartment, and the downstairs was a restaurant. Both units were leased but the restaurant was new. The restaurant's newness was a major factor in completing this loan, but the client's small income was not. The client had modest personal income from two part time jobs she held; certainly not enough income to qualify just on that basis. As a matter of fact the client suggested she would need stated income. She did not - the income from the two tenants was strong enough to support and debt service the loan. Her income was not a critical factor in getting the loan completed because of the lease income produced by the property. Many clients are not aware that commercial stated income loans are mostly non-existant these days (stated is mostly hard money in this market). Likewise however many clients feel that they need high personal income to qualify for a commercial loan, and while strong earnings are not a bad thing, there are situations where it is not needed.
The key thing to remember in commercial lending is that the loan is made more on the strength of the building, and less on the strength of the borrower. I have one client who is fairly new to the United States who happens to have a great deal of money, but no actual job. She has established residency and established credit. She has enough money to make a commercial purchase, and plans to buy an apartment building. Basically, her down payment will need to be strong enough to make the lender comfortable (perhaps fifty to sixty LTV), and her loan will need to be small enough so that the income produced by the tenants debt services the new loan to the satisfaction of the lender. Essentially, this consumer is converting an asset (her cash) into an income stream collateralized by commercial real estate.
I have another retired client who has some modest social security income whos primary means of income is a medium sized retail center that he owns. His new loan will close in the next week, and our challenge here was demonstrating to the lender that there was sufficient equity in the project to protect the lender. Additionally, we had to demonstrate to the lender that the income produced by the retail center was strong enough to debt service not only the new loan but to also support the client's living expenses, since in this instance the retail center was the primary source of income for the client and his family. There was some question about the viability of some of the client's tenants, but these issues were resolved. It is not unusual in this climate for lenders to require a review of tenant financials, which while highly intrusive is nontheless a fairly common requirement to complete a loan. In the case of this loan, we were able to demonstrate enough support for the loan that we were able to generate some cash out funds which will be used to re-surface the parking lot and make a few other minor repairs on the property.
The interesting thing about commercial lending is that in the opposite situation (to the above) high personal income does not usually trump (or compensate for) a building that performs poorly (weak income flow). The reason for this is that, for commercial properties, income determines property value. Better to have an ugly building that generates cash flow than to have a pretty building that does not.
Another way to look at this is on the basis of cap rate. If you are considering a purchase, and the property shows a cap rate of anything less than 9-10, then the property is overpriced. Often I will see Realtor fliers trying to justify a cap rate of 3-5; the best way to react to this is to walk away quickly. No lender will ever accept or underwrite a property on the basis of a cap rate below eight, unless there are some spectacular compensating factors.
The point is that the property must debt service the loan. I have seen some lenders that allow a "global" cash flow analysis, which is lenderspeak for using the client's personal income to compensate for a property that does not generate the income needed to stand on its own. In a market such as this one, with bargains available, there is no reason to accept any property overpriced and not generating income needed to support a cap rate of 9 - 10.
A smart investor looks at return on investment; and I have never yet seen a building be a good long term investment that did not debt service and cash flow. Don't buy for "equity growth" or appreciation of value - if you are fortunate enough to have that happen then good for you. But stick to the fundamentals with commercial property....and there is really just one key fundamental; income.
contact: chuck@bayareacf.com 650-631-1800
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