Selecting the right small-balance lender can make or break a deal

Keith Van Arsdale, president and CEO, BMC Capital

As published in Scotsman Guide's Commercial Edition, September 2012.

In the past few years, the focus of the commercial real estate industry has been on the capital markets’ recovery, particularly for trophy assets and large loans. All eyes have been on new deals that involve an acquisition or refinance loan of, for example, a $70 million prized asset in New York or Los Angeles.

It’s true, as many commercial mortgage brokers may know, that the best quality assets historically led recoveries in the commercial real estate market — and this recovery is no exception. What has been overlooked, however, is a well-kept secret in the small-balance sector. This sector, which ranges between $500,000 and $5 million, also has experienced a lot of improvement in the past two years. Capital has flowed back into the small-balance sector, and there are attractive financing options for today’s property investors.

The small-business market has seen many changes since the frothy capital markets of 2007. The following are some of the changes in loan underwriting that borrowers and commercial mortgage brokers alike should be aware of when they seek permanent financing for small-balance loans.

• Local borrowers: Lenders prefer borrowers to be in the market where the property is located.
• Post-closing liquidity: Borrowers must have sufficient liquidity post closing — for at least nine months.
• Schedule of real estate owned (REO): A borrower’s schedule of REO will be carefully scrutinized for performance.
• Historical cash flow: The loan will be based on historical operations for the past year, six months or three months (T12, T6 or T3). There is no pro forma underwriting.
• Cash out: Cash out is difficult to achieve with the typical loan-to-value (LTV) ratio in the 65 percent range with at least two years of seasoning required. Most lenders prefer 10 percent equity retained  in property.
• Tertiary markets: Lenders prefer markets with a minimum population of 50,000.
• Nonrecourse: There are less nonrecourse loan options for borrowers for loans of  $5 million or less.

Commercial mortgage brokers play a critical role in ensuring that the loan fits the borrower’s investment goals. By doing so, the broker and the borrower alike will be able to proceed in the right direction and choose the best course of loan execution. There are a few questions that need to be answered before applying for a loan:

1. What is the borrower’s investment horizon? Understand whether the borrower plans to keep the property for five years or longer, as well as the borrower’s perception of the property in terms of value.
2. Does the borrower aim at maximum cash flow or principal pay down?
3. Does the borrower want a recourse or nonrecourse loan?
4. Does the borrower plan to trade up to a larger property?
5. Does the borrower want a rate-and- term or cash-out refinance?
6. Where is the property located? Tertiary markets with a population of 50,000 or less are likely to find it challenging to locate capital sources.

 

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