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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   August 2016

Ask the Right Questions Upfront

Borrower and lender expectations should be made clear at the start of any loan transaction

It happens all too often. A mortgage broker submits a commercial-property loan proposal to a lender and, at some point in the process, the deal falls apart for one reason or another.

More often than not, the blame is cast on the lender. Many times, however, it can be attributed to the broker who created or contributed to an 11th-hour problem that not only cost that broker a commission, but also the confidence of the client.

Commercial loans are not one-size-fits-all. There are some loan-approval criteria that will cause one lender to be preferable over others, assuming those particular criteria are a priority for the client or are required for the transaction to gain approval. There are landmines in every process and with every lender. Knowing how to navigate them is the key to a broker’s success.

Key Points

Additional questions for commercial mortgage brokers to ask:

Clients:

  • Are there current long-term leases or are there month-to-month tenants? Not all lenders accept month-to-month tenants due to the inherent risk.
  • Does the property have any tenants with subsidized housing? Many lenders will spurn transactions with subsidized tenants. In addition, a broker will need to garner additional information from the borrower (i.e., rent registrations) to ensure compliance with the subsidized-housing program.
  • What expenses are the tenants responsible for? Knowing what expenses to include or exclude from the debt-service coverage ratio (DSCR) calculations is key to every transaction in order to accurately calculate the ratio.

Lenders:

  • Is global cash flow calculated, and if so at what ratio? Even a property with a high DSCR can be declined because of global cash-flow shortages linked to a borrower’s personal income.
  • Do you qualify borrowers based on market rents, current rent roll or use the trailing 12 months? Knowing what each lender takes into account when qualifying a deal cannot be stressed enough. Go in depth to avoid pitfalls.

Borrower questions

When a broker is at the start of the process of originating a commercial mortgage deal, there are many questions that should be asked of the borrower before a decision is made about which lenders to approach with a funding proposal. The direction of each transaction should not be based solely on rates and terms, but rather on a checklist of multiple items that, if not adequately addressed, can stop a deal in its tracks.

For example, here are just a few questions that should be posed to any potential client:

  • Is the borrower seeking a full-recourse or nonrecourse loan? Many small-balance commercial loan clients do not know the difference, but it is important to determine if one or the other is a prerequisite for financing. Providing offers for full and nonrecourse financing is prudent.
  • Is the borrower’s personal income verifiable and does it support all nonrelated debt? Many lenders will analyze global cash flow, not just the debt service of the subject property. Evaluating total income will allow a broker to better determine the best-suited lenders for the transaction.
  • Is the property’s income reported on the borrower’s tax returns? Historical income and expense information, if it differs from current figures, can be a deal breaker. Although there are some lenders that do not require tax returns at all, it behooves a broker to compare current income and expense reports to prior years.
  • Are all of the units in the property occupied? Although some lenders may give market-rent consideration for vacant units, for certain lenders, too many empty units may bring the vacancy rate to a percentage that does not qualify for financing.

Once this information, and more, is obtained, the broker will have a better idea of where to place the loan. It is imperative that the brokers have detailed knowledge of their intended lenders’ guidelines, underwriting criteria and costs (including third-party costs). Knowledge of every aspect of a lender’s programs and process can eliminate many last-minute mishaps that can derail a transaction.

Lender questions

Likewise, there is a set of key questions that brokers should ask prospective lenders. Following are a few of the queries that should be posed to a potential lender when establishing a relationship:

  • What are your bank’s fees and when are they payable? Don’t surprise clients with good-faith deposits or commitment fees they were not expecting.
  • What are the third-party costs (legal, appraisals, etc.)? This is critical because third-party fees can vary drastically from one lender to another. Some lenders have a legal fee equal to a percentage of the loan. Brokers should know all fees involved for each lender they do business with.
  • What expenses do you include in your DSCR calculation for the property? This is a calculation that can vary, especially with respect to reserves, maintenance charges, management fees, etc. Knowing each lender’s “formula” will sometimes be the determining factor in where a broker places that next loan.
  • Do you “stress test” deals to qualify a borrower, or use the initial starting interest rate? Not all lenders qualify off the “start rate.” Some will stress the deal at rates 1 percent to 2 percent above the starting rate, and a borrower’s approval depends on qualifying at that level.
  • Do you require an environmental report or screening, or a property inspection? These can be included in third-party fees, but brokers rarely inquire if these inspections are required. They are costly and can uncover land mines that can upend a transaction.
  • Does the loan need to be approved by committee? At many institutions, the dreaded loan committee meets once a week, or once every two weeks, and renders a decision on a loan after a five-minute presentation of the deal. Try to avoid lenders that use a committee to approve loans, and opt, instead, for those that rely on the opinion of an underwriter.

Every broker also should have at least three or more lender options for each property type handled and in each state in which business is conducted. Brokers also must keep abreast of every guideline change, including the geographic exclusions
for each lender in their network.

This is just a small sample of the questions that can, and should, be asked of lenders before moving forward with a loan transaction. If you are a broker and have lost a deal because you did not thoroughly vet your lender’s program and criteria, or the borrower’s requirements and qualifications, then a hard lesson was learned. It should prompt you to be more detail-oriented in the future to avoid pitfalls and to make the best use of your time.

Deal options

As a broker, you have options. This is what sets brokers apart from lenders. Lenders are like restaurants with only one item on the menu, while brokers have a menu that contains multiple offerings.

For every transaction, a broker should have a “Plan B.” Every broker also should have at least three or more lender options for each property type handled and in each state in which business is conducted. Brokers also must keep abreast of every guideline change, including the geographic exclusions, for each lender in their network.

Brokers should create a matrix of their lenders that includes pertinent loan-review and other important criteria, and they need to update that matrix periodically. The key to success for any broker is to think, and act, more like an underwriter and less like a loan officer. 

• • •

Do not leave anything to chance. Every broker should have the skill set to underwrite a loan with the same acumen as the underwriter reviewing the deal.

It may take time to learn, but that skill set will give a broker confidence in every transaction originated. This ability also will enable a broker to filter loans early on in the process to determine their feasibility, to choose the right lender option for the deal and to increase the odds of originating transactions that close smoothly and without issues.


 


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