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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   May 2016

Uncomplicated Underwriting

Lenders seek information that is simple and straightforward, yet essential


An effective executive summary to accompany a loan application:

John Smith is requesting a refinance of his 30-unit apartment property located at 123 Main Street. The property recently appraised for $2 million, and there is an outstanding loan of $800,000 with ABC Bank, which matures in six months and needs to be refinanced. The current rate is 5.5 percent, and the loan is open to prepayment in three months without penalty. Mr. Smith also is seeking cash out of $250,000 to replace the roof and pave the parking lot. The new loan request will be $1.1 million to pay off the first, provide cash out and cover closing costs.

123 Main Street was built in 1970 and completely renovated in 2012. The property consists of 30 apartments. There are eight studios, 12 one-bedroom units and 10 two-bedroom units. Rents range from $750 per month for the studios to $1,300 for the two-bedroom units. The property is fully occupied with 29 rentpaying tenants and one free unit provided to the super. The property is located on 1.5 acres and has parking for 60 cars. The building is three stories and has an elevator. Common-area facilities include a laundry room and children’s playground.

Mr. Smith purchased this property in 1990 for $925,000 and refinanced in 2012 when he performed the renovation. Mr. Smith also owns two other apartment properties in the same neighborhood. He has cash liquidity of $275,000 (bank and brokerage accounts), net worth of $4 million and credit scores of 720, 735, and 740. Mr. Smith is seeking a loan with a 10-year fixed-rate, 30-year amortization and a step-down prepayment penalty. He also is seeking a nonrecourse loan. 

Loan applications are put together in many different ways before they land on an underwriter’s desk. Some borrowers and originators submit a simple one-page request, while others submit reams and reams of paperwork upfront.

Neither approach is ideal: Commercial loan underwriters do not have the time to read through hundreds of pages of tax returns and other data when deciding whether to pursue an application. A one-page synopsis does not usually provide enough detail either. 

Underwriters and other decisionmakers need a clear and concise package that can be read quickly and understood. There are some standards you can apply to create an effective loan application with information that is most likely to get the loan approved.

Executive summary

In a typical apartment-loan application, begin with a short summary of the property, borrower, qualifications and loan request. The property-information section should indicate whether the transaction is a purchase or refinance and include the purchase price, property value, loan balance or request, downpayment amount and requested terms.

It also should include a quick description of the property, occupancy percentage, amenities and anything unusual or outstanding. The borrower-qualifications section should include the borrower’s net worth, liquidity, credit scores and experience owning or managing similar properties. The loan-request section should clearly list the type of loan and terms requested. In reviewing just a few short paragraphs, and in just a few minutes of reading, underwriters can decide if loan requests meet their institutions’ guidelines for financing. If the loan does not meet the guidelines, you will receive a very quick “no.” If the loan is of interest, you will have piqued the underwriter’s curiosity and accomplished the very important task of getting the underwriter’s attention quickly.

Profit-and-loss statements

Now that you have the underwriter’s attention, you need to focus on the profit-and-loss statement (P&L) for the property. You need to provide two full years of operating history — either two full calendar years or two trailing 12-month periods.

The P&L should include three sections: income received, normal operating expenses and capital expenditures. The income section should list and detail income received from all sources, including rents, parking, laundry, vending, application fees, late charges, etc.

If there are any wild or unusual swings in income for any category, they should be explained in a footnote. The expense section should include allowances for vacancy, management fees, taxes, insurance, utilities, payroll, garbage, repairs and maintenance, reserves and general administrative costs. The expenses must make sense and be reasonable given the location and size of the property. Underwriters have certain minimum standards that they apply to each level of expense, even if they are not included on the P&L.

For instance, 5 percent for management and 5 percent for vacancy might be used. When it comes to insurance, many underwriters will use a minimum of $300 per unit per year. Repairs and maintenance might be estimated at $750 per unit per year. Be aware that sellers have an interest in stating very low levels of expenses, but underwriters will be more detailed and conservative.

The capital-expense section should list clearly any long-term capital expenditures, such as a new roof, windows, boiler, etc. These are expenses that are depreciated over many years and should not be included in normal operating expenses. Underwriters often look at industry standards for an expense ratio, which is often between 40 percent and 45 percent for apartments. This means that a typical property would have $40,000 to $45,000 of expenses for every $100,000 of income. Expenses that are higher or lower than the typical range will be scrutinized carefully.

Rent roll

Underwriters will want to see a current rent roll. It’s worth emphasizing the word “current.” The rent roll must be no more than 30 days old.

Include several photos of the interior of the units, exterior of the property and street scenes. Let the underwriter see specifically what the loan is funding.

Underwriters do not want to know who occupied your property last year. They want to analyze current income. Any unusual vacancy rates should be explained upfront. The rent roll should include the unit number, unit size (number of bedrooms), current occupancy status, lease start date, lease end date and current rent.

Underwriters will look to see if the vacancy rate is in line with the market. They will look at turnover and how long the tenants have been in place as a sign of good or poor management. They will look to see if rents are at or below market levels. Low rents often are a sign of management woes and a need for property improvements. Underwriters also will look to see if the rent roll is trending up or down. Negative trends will need a solid explanation. Do not wait for the underwriter to ask. Address any problems in the executive summary of the loan application.

Digital photos

Include several photos of the interior of the units, exterior of the property and street scenes. Let the underwriter see specifically what the loan is funding.

Any areas that need improvement should be detailed in photos. Don’t wait for the appraiser to be the first to document deficiencies. Address them clearly, rather than delaying the inevitable and having a problem a few weeks before closing. You can’t hide the truth and should not assume that the lender won’t inquire.

Lenders also will require property inspections. If there are concerns about a property’s condition, have the borrower get cost estimates for improvements before applying for the loan, and include those estimates in your budget. Take a close look at the street scene, and put yourself in the underwriter’s position. Is there a gas station or dry cleaners nearby? If so, the property might need an environmental report. This can take weeks and should be addressed immediately to avoid delays at closing.

•  •  •

The underwriter will definitely ask for more detailed documentation, such as tax returns, financial statements, a survey, etc., if the loan moves forward. Don’t burden the underwriter with all of this additional paperwork at the beginning of the process, however. All that does is delay the decision by taking up too much of your underwriter’s time.

Keep it simple. Submit the documents necessary to determine if your underwriter is interested in your project. If the prospective loan sounds good, the underwriter will usually issue some proposed terms, or offer a letter of interest, along with providing a list of documents that will be required for processing. Sometimes, less is more.


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