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   ARTICLE   |   From Scotsman Guide Residential Edition   |   June 2007

Get Out of the Slump

Look at the small-balance-commercial market to pick up your business

As a residential loan officer, you have two choices regarding shrinking mortgage production: Wimp out or fight back. One way to fight back and capitalize on the shrinking market is to take advantage of the growing small-balance-commercial-mortgage market. By doing so, you can boost your pipeline and income.

The small-balance commercial market represents a vast national market demand. As your residential experience likely has indicated, not every borrower, despite having good credit, can document every cent earned. Your residential solution was a stated-income program. Your approach to commercial mortgages also can be stated-income. Essentially, it’s the “same” borrower with the same problem; the only difference is that the property type is now commercial, not residential.

Potential small-balance borrowers often visit their local bank branches for their commercial mortgages. Either they have a commercial balloon payment coming due, they want to buy a building for their business, or they want to make a commercial real estate investment. Many of these applicants are rejected by their rigid, friendly neighborhood bank, however. Commonly, these borrowers are denied a mortgage because they cannot adequately document their finances. (You know the type: terrific credit, but tax returns indicate a net taxable income of 19 cents.)

All in all, these bank rejections comprise millions of dollars just waiting for the bright, aggressive mortgage broker to step up and solve the problem. Unlike many elective residential mortgage transactions, a large percentage of these bank-rejected commercial borrowers must secure financing. They do not have the luxury of choice.

If you’re willing to give the commercial market a chance to bolster your fee income; and if you’re willing to fight rather than surrender to current residential-market conditions, there are some things pointers you should consider.

Property types and borrowers

First, you must learn to avoid hopeless deals. Don’t waste your time on oddball commercial opportunities. A 95-percent loan request on a golf course that has not yet been built might be hard to fund. A mortgage on a church/gas station/carwash/bowling alley combo likely will not appeal to lenders. And a funeral parlor/convenience store with gasoline combo probably will also be uninteresting to lenders.

Avoid these lost causes. They waste your time, dull your enthusiasm and can make you look foolish in the eyes of your prospective clients.

Instead, maximize your success by seeking vanilla property types, such as office, retail, mixed-use, multifamily and light-industrial warehouses. These represent the bulk of the market.

In addition, prequalify your prospective borrowers. Look at their credit scores, available cash, loan purpose and the extent of their past commercial real estate investment experience. Avoid borrowers whose dreams far exceed their credit, experience and wallets.

Finally, learn the importance of cash flow. Buying a commercial investment property such as a multifamily building is like buying a business. The more a business earns, the greater its value. It is the same for the income property. The higher the net income generated, the higher the appraisal likely will be.


You also must become familiar with common commercial terms such as rent roll, operating statement, net operating income (NOI) and debt-service-coverage ratio (DSCR). Being comfortable with these items will help you better understand what constitutes a viable deal and what conditions will appeal to commercial lenders. Having a general grasp of these terms also will let you quickly assess, in a broad sense, whether the transaction makes economic sense.

In short, a rent roll is nothing more than a list of tenants, unit/apartment numbers, unit sizes, lease start dates, lease end dates and monthly rent paid. Wholesale lenders often will provide fill-in-the-blank rent-roll forms. The recent tally shows the gross income a building currently generates.

An operating statement basically is a written listing of the building’s annual expenses. Expenses refer to items such as real estate taxes, hazard insurance, and reserves for repairs, utilities, management and vacancies. The lender usually provides easy, fill-in-the-blank versions of this form, as well. Be aware that some sellers and real estate agents either “fudge” on actual expenses or innocently fail to include costs.

The NOI is calculated by deducting annual operating expenses shown on the operating statement from the annualized gross income shown on the rent roll. The NOI is the net income calculated before taking into consideration the mortgage principal and interest (P&I) payment.

The DSCR determines a building’s profitability. For example, if a building has an NOI of $100,000 and the annual mortgage P&I is $80,000, you would divide $100,000 by $80,000. The result is 1.25 DSCR. This indicates a profitable building.

In contrast, a DSCR of 1 would mean the building is breaking even, and a DSCR of .9 shows a building losing money. Most lenders require specific, positive DSCR levels for underwriting approval.

Why is DSCR so important? Because stated-income programs cannot verify the borrower’s income, the building’s income plays a critical role. Lenders look to the building to repay the debt. In addition, commercial appraisals commonly seek two approaches when reaching a property value: market approach to value or income approach to value.

Some of your small-balance transactions may be owner-user properties. Because borrowers usually do not pay rent to themselves, you still must determine the fair-market-rent value for the owner-user space. In simple terms, if borrowers moved out of this space, how much rent could they get for it? This fair-market-rent potential indicates property value and how much mortgage the building could support if rented.

Gathering information

Rent rolls and operating statements are vital. And you must also determine fair-market-rental potential. Commercial real estate agents commonly have done their homework and are a viable resource. Owner-sellers also can be a resource.

When presenting rent rolls and operating statements to your lender, do not guess at the numbers. Based on what you and the borrowers represent, a lender may issue an approval subject to third-party reports. Borrowers will have to advance the fees to start the appraisal order. Appraisers will discover bogus or inflated numbers. Therefore, you should save time and money by providing facts, not fiction.

Also, help your borrowers understand the fact that commercial mortgages require costly third-party due diligence. A summary appraisal may cost between $1,800 and $3,200; environmental reports can range from $750 to $3,500 depending on the extent of report; and lenders’ attorney fees to review items such as title, survey, trusts and limited-liability corporations, may be one-quarter percent to 1 percent of a loan and more. Set aside your residential closing-cost mind-set and grasp commercial closing costs. Also prepare your borrower.

Because of the complexity of commercial appraisals and environmental reports, closing a small-balance-commercial mortgage may take as many as 50 to 60 days. Be sure to examine the sales contract to determine if the closing date required provides enough time. Do not assume that real estate agents working the contract will have a grip on the facts.

Help also is available. Most small-balance lenders are aware that many residential pros are green when it comes to commercial mortgages. Recognizing this, the lenders’ representatives often will provide much handholding. It benefits both sides to work together to get to the closing table.

•  •  •

You will not become an overnight success in commercial brokering. But with tenacity and intelligence, you can attain that goal. The marketplace is screaming for small-balance, stated-income commercial mortgages. If you learn to play a productive role in this market, it’s yours for the taking.


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