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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   December 2009

Be Diligent All Around

Your next project or lender might not hold water, but are you prepared to make that call?

Commercial mortgage borrowers face many costs when seeking a loan for a property or project. As borrowers' link to lenders, mortgage brokers are in a prime position to help their clients understand these costs and why they might be necessary.

Many lenders charge upfront fees for conducting due diligence, for instance -- a point of contention for some borrowers. Many borrowers may have heard horror stories about lenders, or even companies that are simply acting as lenders, charging for due-diligence services but not proceeding with the loan.

As their broker, you can help your clients understand what the due-diligence stage typically entails and why some lenders might charge for it. You also should do your own due diligence on the lenders to which you submit your clients' deals so that you ensure that you're dealing with a reputable company. Here's how.

Understanding the process

When it comes to due-diligence services, borrowers often must pay upfront deposits when they are seeking a loan with hedge funds, private lenders or opportunity funds. Traditional lenders, U.S. Small Business Administration lenders and most private-equity firms do not charge deposits for due diligence.

Due diligence can take many forms and can range from "relaxed" due diligence to "tight" due diligence. Today's market has resulted in lenders leaning more toward the tight side of the spectrum. Although lending firms will create deal-specific due-diligence requirements that consider each project's individual circumstances, they often include the following:

  • Legal review of all documents, including junior or equity loan or investment documents
  • Credit, financial and background checks
  • Site inspection
  • Title and survey review and lien searches, including existing title policy
  • Review of historical operating statements
  • Review and approval of operating plans and budgets
  • Market-and-demand analysis
  • Review of all material contracts and agreements
  • Review of all required entitlements, permits, licenses and approvals for the property and any necessary or planned renovations
  • Insurance review
  • Phase I environmental site assessment report
  • Appraisal review
  • Third-party property-condition report and structural-engineering report review
  • Review of any other third-party reports deemed necessary

This list represents, in part, what borrowers are paying for. Costs may range from $5,000 to $250,000, depending on the type of firm with which you are working and on the deal specifics. Often, a portion of your clients' deposit is refundable.

Examining the lenders

If your clients' project or business has acceptable parameters for today's market, your clients should be able to secure the capital they seek -- as long as you are dealing with a reputable lender. It is essential, therefore, that you also complete due diligence on the lenders to which you are submitting your clients' deals.

Many people seem to spend more time researching and doing due diligence when buying a new TV than they do when selecting a mortgage lender with which to work. In addition, while business-owners and developers will spend weeks, months or even years developing a successful business, they often treat the securing of capital or equity as an afterthought. Obtaining capital, however, takes planning, homework, diligence and a fair amount of time to achieve success.

As their mortgage broker, you can help your clients by ensuring that the lenders to which you are submitting their deals are reputable. By asking for the following information before you submit deals to a lender, you can determine their legitimacy and help your clients feel more secure that any upfront money they might have to pay won't be wasted:

  • Are you a direct lender or investor? If they state that they are a direct lender, ask where their funds come from. Some groups will say they cannot disclose that information, but in fact they can -- you are just asking for the source of funds, not specific names of investors within a fund. If they refuse to give you this information, that should be a red flag. You can dig further by asking for the name of the entity through which they lend. You can then examine Uniform Commercial Code filings or search a database such as LexisNexis to ensure that this entity has been actively making loans and investments.
  • Ask for references from other borrowers to whom they have loaned money or invested with. Ask for phone numbers so that you can speak to these references. Also, ask for deal references that are similar to your clients' deal. If a lender has never done a similar deal, you probably should question why it might consider the one you will propose.
  • Do you accept third-party reports ordered by the client? When planning their investment, your clients may be able to prepare the due diligence before you submit their deal to a lender. If they are going to have to pay for it anyway, this might be a good way for your clients to include it in their financial planning upfront and provide the data to the lender along with the loan package. Some lenders will not allow you or your client to order third-party reports, however, because their internal operating procedures require them to place the orders according to their own parameters and guidelines.

Many large hedge funds and opportunity funds likely will not give you some of the information you request. If you are dealing with a multibillion-dollar fund or investment house, however, it shouldn't be too difficult to conduct simple due diligence on them to ensure you are dealing with a qualified source.

Lenders typically are selective with the funding opportunities they pursue, and you should be just as selective with the funding sources you approach for your clients' deals. 


 


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