As published in Scotsman Guide's Commercial Edition, December 2007.
In the world of owner-user finance, cash is king -- and the source of repayment is of utmost importance to lenders. Because the property itself doesn't produce income, that repayment source is essentially the business's net income minus the borrowers' personal expenses. When working with owner-users, therefore, it's important to understand their current and expected cash flow and net income.
If your owner-user clients seek to purchase a property, chances are they have a thriving business. After all, business-owners typically consider real estate acquisitions only when they need to expand a facility or when their business is secure enough to lock in a longer loan term.
The lender will expect the business to produce enough extra income for the borrowers to have at least a 10-percent to 15-percent downpayment. Further, the business should show positive cash flow. This, in turn, produces positive personal cash flow to the owners. In other words, business and personal cash flow combined -- aka "global" cash flow -- must be solid for the borrowers to qualify for a loan.
Cash-out refinances can be complicated in owner-user scenarios. Many business lenders are reluctant to finance a building where the business encumbers additional debt that doesn't directly benefit it. As such, lenders generally require borrowers to use refinance proceeds to further business goals (e.g., make renovations, increase working capital or finance new equipment). In addition, because owners occupy the property, lenders worry about vacancy in the event of default.
If your clients want to borrow from their business property to finance personal expenses, this could indicate weak cash flow. While an investment-property lender on a generic multitenant property may be willing to lend to borrowers with personal cash-flow issues -- especially if the property meets debt-service requirements -- there is no such thing as an owner-user "bailout" loan. If the business is struggling, more debt won't help.
Lenders for owner-user properties come in all shapes and sizes -- from small community banks to national lending giants. Because not all lenders work with all types of businesses, it's important to understand variations. For example:
Mr. Smith wants to purchase the building that houses his bait-and-tackle shop in Wyoming. His business is profitable every year, but he's more than 100 miles from the nearest city with more than 25,000 people. He doesn't sell much during winter.
The best choice for this transaction may be a local community bank. Unlike a regional or national bank, a local bank will understand population fluctuations and tourism patterns. Instead of seeing a downward trend in the interim financial statement, a local bank will likely understand that the business has a seasonal income stream in which gross sales increase dramatically.
Ms. Jones would like to refinance her restaurant in California. She acquired the business and the property five years ago with high-interest, short-term financing. Now she wants to fix her payment at a lower rate and longer term. She received Small Business Administration 7(a) financing for her business acquisition and real estate purchase. The 7(a) program can do one loan for both elements, but the rate will be adjustable at a spread over prime, and the term will be blended.
Assuming positive global cash flow, this borrower is a prime candidate for a refinance with a regional or national lender. Large national lenders will likely offer the best rate but might lower the maximum allowable loan-to-value ratio for this special-purpose property. A regional lender, meanwhile, may offer a higher rate but will likely be more broker-friendly and flexible with the property usage.
The more you understand borrowers' stories on the front end, the more often you'll find the right lender and best address concerns during the underwriting process.
Robin Pitts is a sales executive for advisor services with Everbank's Commercial Real Estate Lending Group.
She specializes in owner-user financing and offers more than 10 years of experience in credit and originations of financing options for owner-user, Small Business Administration and investment property. She can be reached at (714) 908-5282 or firstname.lastname@example.org. Visit the company's Web site at www.everbankcommercial.com.