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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   October 2005

The Unfundables

Save yourself wasted effort  look for the red flags on loans that don’t stand a chance

Unfortunately, not all commercial loans close. It is mind-boggling how many deals lenders see that have no chance of ever funding.

Deals that never fund typically fall into three primary categories:

  • Properties that are too special-purpose (e.g., catfish farms or mining claims);
  • Properties in which borrowers seek 200-plus-percent financing on a purchase because they are getting a “great deal”; and
  • Properties in which borrowers are looking to get a loan based on best-case pro-forma financials or overly optimistic appraisals.

Every broker reading Scotsman Guide sees deals that fall into one of these categories. Most new brokers, or those transitioning to commercial deals, can be mesmerized by the possibility of closing a large loan. As a result, they spend many fruitless hours trying to place these loans. Many such brokers send lenders large packets and call multiple times to discuss the “urgent” deal. But in many cases, they don’t even fully understand the deal they are trying to fund.

Let’s try to calculate the resources spent chasing these deals. Assume a broker expects to make $50 per hour (equal to about $100,000 per year). Say this broker spends eight to 10 hours on each deal. If a broker works on 10 dead-end deals a year, it would be the equivalent of wasting about $5,000 a year. That doesn’t even include the additional costs incurred by such things as lender-evaluation fees and administrative time spent by employees.

Loans that can’t be closed are often easy to spot. These are just a few key red flags to watch for:

  • Vague details: Often, borrowers will be unable to provide basic facts (net operating income, number of units in the complex, current tenants, etc.) or will act elusive when talking about the property.
  • Unrealistic income/rental numbers: It is apparent when numbers are out of line with reality. If the owners say they are renting an 8-by-10-foot mini-storage unit for $500 per month in a rural market, the figure can’t be accurate if three-bedroom brick homes in that market are going for the same amount.
  • Optimistic appraisals: If the only available comps are too far from the property in question or if they appear considerably nicer than the subject property, then the appraisal is probably too optimistic. Also, one should be wary when an appraisal for a commercial property was done by a residential appraiser.
  • The deal doesn’t make sense: Frequently, the details of the deal do not add up and are illogical. For example, a borrower is purchasing an apartment building in which units are currently renting for $800 per month. The borrower feels that the property value should be based on a $2,000-per-month rental because rents will be raised immediately upon purchase of the property. However, there is not usually such a large disparity in rents.
  • Unrealistic borrower expectations: Often, borrowers will have poor credit or a property that does not have sufficient cash flow, yet they want rates and terms aimed at A-paper borrowers/properties. Borrowers with a credit score of 410 or a property with a debt-service-coverage ratio of 30 percent will be unable to get a loan at the prime rate.

Tools you can use

Many tools exist to help brokers easily spot loans that cannot be closed. Reports from data providers, for example, typically cost a nominal fee and are invaluable for quickly identifying possible issues with loans. Providers offer reports that show key pieces of information on a property, including:

  • Last sale date: One can look at this report to see if the property has recently sold. If it did, the sale price is a good indication of the property’s current value. A property purchased two months ago for $200,000 is likely not worth $1 million today.
  • Last-recorded mortgage: This report typically gives the amount of the last mortgage recorded on the property. This information enables brokers to ask borrowers the right questions. For instance, if borrowers claim that they own the property free and clear and a mortgage was recently recorded on the property, a broker can ask to see documentation that the lien has been satisfied.
  • Tax value and comparable property sales: These two pieces of information give a starting point for the valuation of the property. If every comparable property nearby is selling for less than $200,000 and the borrower states that the subject property is worth $900,000, one should question the value.

Another source brokers can turn to is their county’s property assessor’s office, many of which list their information for free online. Assessors can offer information similar to that provided by data providers, but they sometimes offer a less user-friendly search format. This can require more effort on the part of brokers.

There  are also a number of online listing services. Many of these Web sites specialize in commercial listings and most are free to search. They enable brokers to see all the properties for sale and for lease in the area. This information can provide a good indication of a property’s value.

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To maximize the profitability of brokering commercial loans, brokers need to identify loans that fall into the “uncloseable” category and avoid them. This will enable astute brokers to focus on profitable loans that have a much greater likelihood of closing.


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