Obtaining a loan on a commercial property is a tricky business. This writer has just completed two financings with two different lending institutions. Each had their strengths and weaknesses, but each proved to be equally challenging. Let me just pass on some of the lessons which have been reinforced with these most recent transactions.
1) Lending institutions are not in the business of taking risks. They try to mitigate their risks. Lenders want at least two or more sources of repayment. Leases, low loan to value (more equity by the borrower), other collateral pledges and personal guarantees are all common ways that lenders seek to secure the loan. Unless the borrower is an asset rich institution, personal guarantees are usually required. If you live in a community property state, your spouse will need to offer his/her guarantee as well.2) Make sure you do your due diligence up front on your deal. You need to have financial statements, methods of repayment, and a strong personal financial statement in place before you present your loan package to the lender. It would be helpful to have a business plan or executive summary which describes the deal in detail to the lender so that they can explain it to the credit committee.
3) Understand your lender’s policy regarding debt service coverage ratio (DSCR). Most lenders have a strict maximum ratio of 125%. In other words; your net rents must equal no less than 125% of the debt service. What this means is that if you purchase a building on a cap rate of 7.5, then the maximum loan to value (LTV) that a lender will offer will be about 61%. Some lenders will go up to 75% LTV but they will absolutely not break the 125% rule!4) Finally, your loan officer is your friend. Most loan officers work very hard for their clients and sincerely try to get the best deal they can. However, they are constrained by the credit requirements that are set by others at the lending institution. Make sure you are 100% honest and candid with your loan officer and they will usually reciprocate. Remember, they have financial incentives to get your loan approved. They are trying to reach the same goals as you. Treat them as a friend, and you will have a better chance of creating a relationship that will benefit you in the long run.
Next weeks topic: When should you use a real estate broker?
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