Commercial Magazine

Avoid the Short-Term Trap

Don’t settle for anything less than long-term, fixed-rate financing

By Noah Grayson

Sometimes it seems your only choices in funding a commercial real estate deal lead to a short-term trap. You have the option of gambling on an adjustable interest rate, or going for a fixed-rate loan that resets with a new interest rate after a few years. Borrowers who need to close quickly or have special challenges often needlessly choose by default a higher-cost bridge loan, even if they need permanent financing.

But your clients don’t have to settle for anything less than the security of a 30-year fixed rate. Permanent stated- income lenders are offering long-term commercial mortgages for hard-to-fund borrowers and projects. These loans can ultimately save significant money for your clients.

An adjustable, short-term commercial mortgage has its uses. It can be a great vehicle to keep costs down during periods of low interest rates. Many investors choose an adjustable rate when planning a near-term property sale or permanent refinance. In these cases, short-term bridge financing with a 12- to 36-month expiration date is a viable option, provided that the property can be sold quickly. Commercial properties, however, often do not sell quickly.

An adjustable-rate mortgage also can sometimes be a borrower’s only option due to eligibility issues. The U.S. Small Business Administration (SBA), for example, presents one of the most cost-effective financing vehicles for business owners, but the rates negotiated between the lender and the borrower are subject to guidelines established by the agency. A quarterly adjustable loan is often the only choice available. Some SBA lenders will offer long-term fixed commercial mortgages up to a maximum of 25 years, but qualifying parameters tend to be stringent and may not allow the proceeds to be used for working capital, inventory or other needed items.

For investors who renovate property and lease it, the challenge is to find tenants and bring occupancy up to a level required by permanent lenders. Owners, however, may be unable to secure the needed tenants in time or cannot find a way out of a high-cost temporary mortgage. Even for those fortunate or experienced enough to execute a project perfectly and refinance out of a short-term loan, rarely will the permanent mortgage carry a fixed rate for the life of the loan.

Financing trap

There is no lack of permanent commercial mortgages in the marketplace, but what is consistent about most commercial mortgages is the short-term structure of the loan. Permanent lenders will commonly offer a 25- or 30-year amortizing loan, but the fixed-rate period offered by most lenders is still relatively short.

Banks, for example, dangle long-term fixed commercial mort- gages. Long-term bank loans may seem like a good option if you can qualify for one. These loans, however, commonly include balloon payments or loan-structure reset periods at the five-year mark, forcing the borrower to refinance or extend the loan at a higher rate.

Likewise, the fixed terms offered by most nonbanks usually isn’t adequate. Nonbank lenders commonly offer three-, five- or seven-year fixed-rate loans, but many business owners and investors intend to hold a property for longer than seven years. To find longer fixed terms, you have to know where to look. Some nonbank commercial real estate lenders will offer 15- or 25-year fixed mortgages, but their rates are prohibitively high and are better used for longer transitional purposes. Despite that, some nonbank stated-income lenders have stepped up to offer viable long-term loans, including 30-year fixed mortgages, at reasonable rates.

A stated-income commercial mortgage is simply a loan that doesn’t require a borrower to produce tax returns, financial statements or other documentation to verify personal or business income. Two general comments should be made upfront about these products. First, not all stated-income lenders offer long-term fixed loans. Second, permanent stated-income lenders have the ability to fund many of the same challenging borrowers and property types as bridge lenders, but they are a different breed of lender.

Different animals

Bridge lenders often require minimal documentation, but their loans can differ significantly in other ways. They tend to focus on the value of the asset, are uncomfortable with higher leverage levels and want to see a viable exit strategy. Some bridge lenders will require income documentation and some won’t, but all offer short-term loans that essentially “bridge” a borrower from a less favorable situation to a more favorable one. The permanent stated-income loan offers a long-term solution for the borrower.

Long-term stated-income loans tend to carry higher interest rates than other forms of permanent financing. The rate spread can be as much as 100 to 500 basis points above the conforming loan rate with a traditional lender. The advantage is that a long-term stated-income loan provides security over time, requires minimal documentation and can be closed relatively quickly.

The lender is mostly evaluating the underlying asset and its potential for generating income over the long term. The underwriter also will usually consider the borrower’s credit score, although stated-income lenders tend to be more flexible in this regard than banks. With stated- income loans, it’s also possible to finance projects for credit-challenged borrowers or projects that don’t strictly conform to guidelines.

In some cases, for example, a borrower’s income doesn’t meet the debt-service-coverage ratio or debt-to-income requirements of a bank or conforming lender. A borrower who has a credit score or cash flow below bankable guidelines is a good candidate for a stated- income loan. A borrower who needs permanent financing for a challenging property type, such as a bar or restaurant, also would be a good candidate. Permanent stated-income lenders tend to be more common for small-balance commercial real estate loans of less than $5 million. These loans, however, are not suitable for raw-land or construction projects, or for properties in transition. Fast and flexible

A widely held perception is that permanent mortgage lenders always have rigorous underwriting processes, but this is not always the case. Those who fail to do their research and jump into a bridge loan to avoid red tape may end up paying unnecessary loan costs. A permanent stated-income lender offers the same flexibility and speed as the typical bridge lender.

It’s true that many permanent stated-income mortgage lenders offer double-digit rates, but there are those who deliver more competitive pricing. Increased competition among stated-income lenders has driven pricing down on 30-year fixed loans to the 6% range. Additionally, qualifying parameters have loosened, allowing borrowers with credit scores in the low 600s to obtain competitive commercial mortgages.

Another benefit of a stated-income loan is that it can be used to finance various commercial property types. Banks are mainly focused on securing generic collateral only, but many stated-income lenders will finance special-purpose properties.

Since stated-income lenders aren’t beholden to the same regulations that banks are, they are able to offer greater underwriting flexibility. It is not unusual for a stated-income lender to offer leverage up to 80% of a property’s value, provide unrestricted cash out or even allow funds to pay off overdue income taxes. Since these lenders are focused on a property’s cash flow and value, rather than personal income, qualifying for a loan tends to be straightforward.

• • •

Using a stated-income commercial real estate lender that offers long-term financing is a great way to differentiate your product offerings. Offering a low-documentation, 30-year fixed mortgage at an affordable rate will appeal to bankable borrowers looking for a simpler process. Also, borrowers who are used to taking out an adjustable-rate mortgage or bridge loan can now qualify for a more favorable, long-term fixed loan that is just as accessible.


  • Noah Grayson

    Noah Grayson is president of South End Capital, a nationwide, technology-enabled commercial real estate and business lender founded in 2009. South End Capital became a division of Stearns Bank N.A., a $2.2 billion financial institution, in June 2021. 

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