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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   March 2009

Catch New Business with Corporate Lending

Opportunity could lie in areas mortgage brokers may not have considered

In the past, many mortgage brokers looked past different types of deals simply because they were focused on real estate. Savvy brokers, however, look beyond their comfort zones and explore new terrains.c_2009-03_Bogdanoff_spot

One opportunity could be corporate lending. It likely has enough similarities to real estate to allow brokers to use their pre-existing talents. But it also has enough differences to open new doors.

Corporate lending takes place when a company needs funds for any reason other than real estate. For example, a technology company might need additional funds to further develop products, or a clothier might need additional funds to expand into home goods.

The roots of mortgage and corporate lending are similar. Corporate investors make their lending decisions the same way mortgage lenders do. They want to have a reasonable level of comfort that they will get their investment back in a reasonable amount of time and with an acceptable return on investment.

These two loan types also have clear differences, however, including the collateral on which the loan is based, how cash flow factors into the deal and what types of businesses might qualify. Brokers who want to dip their toes into corporate lending successfully should know these differences to recognize fundworthy deals.

Collateral and cash flow

Primarily, corporate loans are based on a business's assets. A company might use its receivables, inventory or equipment as collateral to secure a loan. Although these items might represent millions of dollars, they can be more difficult for lenders to liquidate than real property.

Assume a company used its significant technology investment to secure a loan but could not repay the lender. The lender would have to liquidate the company's computers and other technical equipment that may be obsolete already, making it difficult to collect on its investment.

Many corporate investors know this and are willing to take the risk. To mitigate that risk, they often impose a short loan term, which results in a higher monthly payment for the borrower. A corporate loan might have a five- to 10-year term.

Additionally, corporate lending traditionally examines a business's cash flow carefully. Corporate lenders want to understand if the existing cash flow will support the higher payment.

When looking at cash flow, lenders consider how a business makes it revenue and why it is successful. For many companies, the value of the business is wrapped up in the people running it; if they were to leave, the company's ability to bring in revenue would see great impacts, and the company's value might plummet.

Corporate investors don't want to have ownership in a business that has limited or no value, and they also don't want to make loans that the cash flow doesn't support. The underwriting process, then, scrutinizes the cash flow's predictability and its vulnerability.

Corporate deals in disguise

There is a gray area between mortgage lending and corporate lending. For instance, many people might assume that a bowling alley would require a mortgage loan. In actuality, however, it likely is a corporate deal. This is because the bowling alley's intrinsic value is more directly related to successfully renting the lanes than to anything else. Without the equipment and accoutrements a bowling alley is known for, it's really just four walls and a ceiling.

Taking this example even further, assume that the bowling-alley franchisee owns the building, which is worth $2 million of a $10 million package that includes the brand, equipment and more. The $2 million is a real estate asset, but the franchisee needs to borrow $8 million to complete the deal. Only 20 percent of this deal comes from real estate; the other 80 percent uses assets for collateral and therefore is subject to shorter lending terms.

Another property type that often is better suited for corporate lending -- and that may surprise mortgage brokers -- is hotels. Although hotel loans are closer to traditional real estate loans because the property can easily be converted to apartment units, the hotel's value is really based on how well rooms are rented and how long they are occupied. Typically, a loan to a hotel to refurbish the property would be considered a corporate loan rather than a real estate loan and would be subject to corporate-lending guidelines.

Main considerations

For brokers who are new to corporate lending, the lines between mortgage loans and corporate loans may appear blurred. There are two questions to consider:

  1. Where does intrinsic value lie?
  2. What is the duration of the stay?

For loans related to a property, such as a bowling alley, a hotel, an ice-skating rink or a bar, it comes down to the property's intrinsic value. Is its value built into the four walls, or is it what lies within them?

If it's what lies within them -- which could easily be uprooted and taken to a different property -- it likely is a corporate loan.

The intrinsic-value rule can be more difficult to apply to properties that house tenants. In those cases, brokers should consider the duration of the stay. If tenants are staying on a nightly basis, such as in a hotel, it can be difficult to predict future revenues. In these cases, it would likely be a corporate loan.

For tenants who are committed for a year (e.g., an apartment house) or for five or more years (e.g., an office complex), the value typically lies more with the actual building and would be eligible for a real estate loan.

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Mortgage brokers have the skills and experience to earn significant returns in the corporate-lending market. The lending processes are similar enough for brokers to make good use of their real estate background. But they also likely are different enough to help deals that may otherwise go overlooked.


 


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