As a commercial mortgage broker, lining up financing for cash-flowing properties is generally straightforward. Properties that are not cash flowing (such as a vacant property) and construction loans, however, can be a bit more complex because the initial analysis from a lender’s perspective is a bit more involved.
That’s why mortgage brokers interested in pursuing such deals should first learn the lay of the land on the financing side. First, let’s examine the approaches used in financing a cash-flowing property compared with a property that is not cash flowing.
Determining financing options for conventional cash-flowing properties normally begins with analyzing the net operating income (NOI) and applying a market-capitalization rate. It is a quick, back-of the-envelope, first-step analysis to ascertain the approximate loan-to-value level and debt-service coverage ratio of the loan request. From there, the lender gets more granular by analyzing the expenses and rent roll to validate the numbers against comparable properties and, of course, an analysis of the property characteristics and market conditions is undertaken as well.
When underwriting properties that are not cash flowing, lenders generally begin with the story behind the deal, as well as financing sources and uses. There are several questions brokers can expect lenders to ask: Why is the property vacant, or why is the borrower acquiring a vacant property? Is the existing property vacancy market driven, the result of a property deficiency, or is it situational? What is the plan to create value (upgrade the building, adaptive reuse, demolition and rebuild, etc.)? How much skin (equity) is the borrower contributing to the project?
If the borrower is acquiring a vacant property and has 25 percent to 40 percent equity being invested in the transaction, then that is generally more meaningful and compelling to a lender than a borrower who has owned the property for many years and has already refinanced most of the cash out of the property’s value through one or more previous financings. Once the story is validated, the lender must then analyze the market conditions and comparables to understand if the project is viable, and to determine the potential income and expenses and, ultimately, the property’s NOI.
The execution risks for the owner are much greater for vacant properties than with stabilized properties, so underwriting these assets will generally require a discount-to-market analysis as a fallback scenario for the lender to feel more comfortable about the potential for project success. Typically, a lender will run projected cash flows using market rents, in addition to a sensitivity analysis discounting the market rents in case the borrower’s projections or their execution falls short or does not come to fruition.
“ It is important to underscore that the key to any loan submission is clear and concise loan-request documentation. ”
In a recent and successful $21 million senior-lender financing transaction involving two properties in downtown Boston, for example, the approval was driven largely by the location of the properties. They were both in a robust Boston market with strong supporting comparables.
In addition, the borrower had a 40 percent equity investment in the properties. Part of that investment was in the form of a third unencumbered property, which the borrower had recently acquired for cash.
Similarly, when underwriting construction loans, the focus is generally first on the loan-to-cost (LTC) ratio and then the loan-to-value (LTV) ratio at completion and stabilization. Banks, for the most part, are lending at 55 percent to 65 percent of costs with full recourse. Nonbank lenders generally provide financing in the range of 70 percent to 85 percent LTC, with completion guarantees.
Decisions for many borrowers in the current lending environment come down to their willingness to sign recourse provisions and/or how to measure the value of a nonbank lender’s higher LTV versus the initial lower cost of traditional bank financing. Choosing a bank loan, however, also normally entails a lower LTV that may require expensive mezzanine debt, preferred equity or additional equity to close. In many cases, this blended interest rate is comparable to that of rates offered by nonbank lenders. It also is worth noting that loan-closing certainty is greater with one capital source versus multiple sources.
Property type also plays a role in the availability of capital. A multifamily construction loan, for example, generally allows for the most aggressive loan-to-cost ratios from lenders.
For construction loans, projected cash flows, a detailed construction budget, information on the architect and general contractor, and zoning/permit information are always required — in addition to the typical information submitted in loan requests. If the property is being developed as for-sale condominiums, for example, then having a rental fallback is quite helpful because it provides lenders with a potential worst-case analysis to support the loan, although rental fallbacks may not work with all projects.
Unlike conventional cash-flowing loans, construction loans rely heavily on current market conditions as well as 12- to 24-month forward trends, as that is the typical timeline to complete the project. In addition, refinancing or property sales will be heavily dependent on the market conditions at that point in time. Obviously, there is not as much room for error with conventional five- to 10-year loans, because rents generally trend up over longer periods of time.
A 45-unit condo project in Denver, for example, recently received a 79 percent loan-to-cost construction loan. This LTC is quite high for senior mortgage lenders, but after evaluating the entire project, the lender found that the LTV at completion was approximately 66 percent. Furthermore, the property had contracts of sale executed on about 27 percent of the units. Plus, the deal was underwritten with a rental-fallback scenario, which offered a secondary exit strategy should the condominium-sales market change for the worse.
It is important to underscore that the key to any loan submission is clear and concise loan-request documentation with all the basic facts and details presented. That includes the following information: an address, property type, pictures, loan purpose, sources and uses of loan proceeds, rent rolls, income and expenses (or projections, in the case of vacant properties and construction projects) as well as borrower background, financials and experience.
This is especially true in today’s fast-paced, technology-driven world where e-mail inboxes are being bombarded and incoming text messages are endless. Because it is becoming more commonplace for mortgage professionals to be viewing incoming loan requests on mobile devices in between meetings or site inspections, forwarding a link to 30 files for downloading is not the best method of piquing a lender’s interest in a project.
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Commercial mortgage brokers and their borrowers are competing for loan-originator bandwidth. Loan-application information that is presented correctly, with the appropriate details, can mean the difference between getting greater attention to your loan submission or having it doomed to oblivion in an inbox purgatory.