The ability to access reliable sources of commercial real estate capital can be fundamental to the continued growth and development of a business. Yet finding a reliable source of long-term debt capital with the needed repayment terms and interest rate may be one of the biggest challenges facing a growing company in today’s volatile economic environment.
This is where commercial loan brokers can be of immense value to their clients who are seeking to borrow money. The loan process usually begins with a broker gaining a thorough understanding of the potential borrower’s financial needs and requirements.
To do this, the broker needs to develop the necessary insights into the business, which requires the applicant to be honest, candid and forthcoming about their current financial positions. Before presenting the borrower’s loan request to a commercial real estate lender, the broker and the applicant must identify the specific financing needs, the benefits of owning the building and the company’s financial and market strengths.
“Many business loan requests are declined because they don’t address the strengths and weaknesses of the deal. The lender is most concerned with understanding the complexity and risk associated with the deal.”
Outlining risk
Many business loan requests are declined because they don’t address the strengths and weaknesses of the loan. The lender is most concerned with understanding the complexity and risk associated with the deal.
The loan request should answer a lender’s questions, and offer solutions to the perceived risks inherent in the deal. This process starts with the borrower answering what is commonly known as the four Hs of credit:
• How much money is needed?
• How long is the loan needed?
• How will the loan proceeds be used?
• How will the loan be repaid?
The answers to these questions can form the basis for a successful business plan. There are several best practices to keep in mind when developing a business plan. Understanding and implementing these practices can increase the chances of securing the needed financing.
Potential success
Before approaching lenders, the borrower and broker should create a business plan that outlines the project, its potential for success and the company’s ability to repay the loan. This plan should include detailed financial projections, market analysis and a clear understanding of how the subject property will contribute to the continued profitability of the organization.
The commercial broker must make sure the plan is complete and written in a compelling manner. Use graphs, pictures, charts and color — anything that will help tell the story in a convincing way. Do not try to avoid or whitewash the borrower’s shortcomings. Openly discuss the weaknesses but find and emphasize ways to limit these issues.
The loan request should be only about six to eight pages long, including a summary of the prior three years’ financial performance and a summary proforma for the year to come. In addition, attach the last three years of business and personal financial statements. The borrower’s financial information must adequately convey a convincing and well-developed financial plan.
Garner interest
The right business plan provides lenders with a comprehensive understanding of the project, its potential for success and its ability to repay the loan. While there are a variety of business-plan formats, the following are some key elements that should be included in a well-developed business plan for a commercial real estate loan application:
Executive summary: This section provides an overview of the business plan, highlighting key points, such as the purpose of the loan, the subject property and the expected financial outcomes. It should be concise and compelling, garnering the lender’s interest and giving them a concise understanding of the project.
Company description: This section provides information about the organization, including its history, organizational structure and ownership. It should also highlight the company’s products, purpose of purchasing the building and how the new facility will contribute to the company’s continuing profitability.
Market analysis: This section denotes the market conditions and trends relevant to the company’s operation. It should involve information on the local market, demand for the company’s product, competition and potential risks and opportunities. Use market data, industry reports and other sources to support the analysis.
The broker should remind the borrower to anticipate a detailed underwriting process which may take considerable time. Lenders will assess financials, credit history, property valuation and other factors to determine eligibility and loan terms. Be ready to provide additional information and expect additional questions from the lender, regardless of the completeness of the original presentation.
Lender evaluation
Lenders have their own unique method of evaluating a potential borrower’s loan request. Most lenders will agree, however, that the most important aspect of a good loan can be classified into three fundamental components: competent management, positive cash flow and adequate collateral.
Competent management is the most abstract and difficult for a lender to evaluate and measure. The concept of “management” consists of many factors, including commitment, experience, flexibility, people skills, leadership and technical competence to name just a few. Simply put, it is the ability to amass needed resources, while thoroughly employing these assets in a manner that will generate sufficient revenue to cover all operating costs, including the timely payment of debt service to the lender, with a reasonable profit remaining for the investor or borrower.
In the business plan, introduce the key members of the management team and highlight their respective experience and qualifications. This section should show that a capable team is in place to successfully execute the business plan and manage the property.
A strong credit history is vital when applying for a commercial real estate loan. Lenders will examine both personal and business credit scores to measure creditworthiness. It is important to keep the best credit score possible.
Lenders are interested in understanding how the borrower plans to repay the loan. Include an exit strategy that outlines how the company intends to generate funds to repay the loan, such as through property sale, refinancing or rental income. This demonstrates a long-term vision and commitment to the project’s success.
Crucial metric
Include any supporting documents that validate the information presented in the business plan. This may include property appraisals, market research reports, financial statements, lease agreements, permits and licenses.
The financial section outlines the financial aspects of the project, including revenue projections, operating expenses and cash flow forecasts. Cash flow (the measurement of the inflow and outflow of money from a business) is a crucial metric for the lender and the main way that a borrower will repay the loan. The financial section should demonstrate the borrower’s ability to generate sufficient income to cover loan payments and other expenses. Use realistic assumptions and provide supporting documentation such as pro forma financial statements and market research data.
Lenders will require various documents to assess the eligibility for a loan. These may include financial statements, tax returns, property appraisals, lease agreements, as well as personal and business credit reports. Be sure to gather and organize all necessary documentation before submitting the loan application.
Clearly state the amount of financing requested and how it will be used. Explain how the loan will contribute to the success of the project and outline the proposed loan terms, such as interest rate, repayment schedule and collateral.
Vital consideration
Collateral is an important consideration for lenders when evaluating loan applications. The property being financed will serve as collateral for the loan, and lenders will assess its value and potential for generating income. It is important to choose a property that meets the lender’s criteria and has sound investment potential.
Finding agreement between the banker and the borrower on the liquidity and realistic value of the property, however, can be one of the most difficult parts of the collateral process. Most business-type assets can have different values, depending on various factors. The lender is primarily concerned with the dollar amount the property will bring from a quick sale. Unfortunately, this usually translates to a sum that is less than the owner’s perceived value.
A broker should collaborate with the borrower to provide a detailed description of the property to be purchased or refinanced. This section should also address the property’s potential for income generation and appreciation.
Lenders typically require borrowers to have a significant equity stake in the project. This demonstrates the borrower’s commitment to the investment and reduces the lender’s risk. Aim to have a substantial downpayment or equity investment in the property to improve chances of loan approval. There is no magic formula or standardized downpayment percentage, but 20% to 25% is most common.
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By following these best practices, commercial brokers can position their clients for a successful commercial real estate loan application. Remember to be well-prepared, maintain good credit, build relationships and seek professional advice. With careful planning and execution, you can help your client secure the financing needed. If the borrower can demonstrate his or her management skills, provide financial data indicating adequate cash flow and offer reasonable collateral to secure the transaction, the chances of securing the loan will be greatly improved.
