Commercial Real Estate Loans

Commercial Mortgages: Take your business to that next level by purchasing the commercial property of your choice, refinancing your property for better rates and terms or find that hard money loan your business needs today.

Overview:

Commercial real estate is one of the most important financial transactions for a non-public entity. (Public companies greatest financial transactions involve maximizing shareholder value). Purchasing commercial real estate; including property (buildings) and land is typically one of the most expensive endeavors a business will undertake.

Not only should the business be concerned about the location of the property but must ensure that the property is suited for the business's long-term growth and sustainability without putting too large an undue financial burden on the company in the present. Your business does not want to purchase or construct a 30,000 square foot building now for $1 million when the company only needs 10,000 square feet now (even if it thinks it will need the additional square footage in the years to come). Your business does not want to over burden itself financially but wants to be sure it can grow as its sales and profits grow.

Moreover, most businesses cannot (or should not) pay for property with cash - cash that can be used to grow sales and increase profits.

Most businesses, seeking to finance their property purchase, soon learn that the hassles of securing a commercial real estate or property loan can cause many, many headaches.

On the flip side, owning your own property and using your business's cash flow to pay for the asset outweighs the negatives like paying a landlord and usually results in larger financial returns in the future through increased revenue and a stronger balance sheet.

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Purpose of Commercial Real Estate Loans:

Not only do financial institutions look to see how your business will make use of the property (they will not finance any illegal operations) but will look at the general purpose of the property in question.

Financial institutions are not in the real estate business, they are in the lending business. Thus, they do not want your property should you default on the loan agreement.

However, many times, banks and other financial organizations do end up owning property that was once collateral on a commercial property loan. To that note, should the lender have to take ownership, it wants to dispose of the property as soon as it can. This reduces its losses and could reduce the overall indebtedness of the business who defaulted.

Therefore, lenders are extremely particular about the types of property they lend against. Financial institutions, even non-bank or non-holding company institutions and investors, seek to lend against commercial property ONLY if it has multiple uses. Specific use properties (single use) like car washes, mobile home parks or churches are not property that can be easily and quickly sold. On the other hand, office buildings, general purpose warehouses and distribution centers can be quickly liquidated to nearly any business in any industry. Just keep this in mind when seeking a commercial mortgage loan.

Moreover, financial institutions and other lenders look at how the business or borrower will utilize the real estate. If the business intends to occupy the property for its operations, the business will stand a better chance of securing the funds to purchase the commercial real estate. Further, owner occupied property should receive better terms and rates as the risk to the lender is lessened (at least in the eyes of the lender).

Investment property or non-owner occupied property is harder to secure, will require lower loan-to-value (LTVs) and stronger financials on part of the borrower plus more stringent terms and higher rates.

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Typical Commercial Real Estate Loan Uses:

• Professional office
• Physicians
• Veterinarians
• Office condominiums
• Flex-space/warehouse
• Day care centers
• Hotels and motels
• Convenience stores
• Gas stations

• Auto repair
• Car washes
• Restaurants
• Funeral homes
• Dry cleaners
• Assisted living facilities
• Nursing homes
• Manufacturing
• Dozens more

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Loan-To-Value:

No financial institution, regardless if it is a bank or non-bank entity will lend 100% of the value of the property. The reason stems particularly from the high average amount of these transactions, the costs in foreclosing, resale and risk.

Most commercial real estate transactions are upwards of $250,000 and more - as opposed to a car loan of $25,000. Thus, if a borrower walks away without making even one payment, the loss to the financial institution is immense. Further, in additional to loss of principal, the financial institution must incur added costs in legal fees for foreclosure and resale.

Therefore, nearly all businesses must provide at the least 20% equity in down payment. This can come in two forms: cash down or a purchase price 20% below appraised value. Very seldom will a financial institution fund more than 80% of the purchase amount. The one rear occasion is a SBA loan - where the SBA guarantee may allow up to 90% LTV provided all other underwriting criteria are immaculate.

If the property is to be used for investment (non-owner occupied), the LTV percentage requirement will be lower - roughly around 50% to 60% - requiring the borrower to put down 40% to 50% in personal or cash equity.

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Cash Flow:

Cash flow is one of the key factors in securing any loan including commercial real estate. The stronger the cash flow, the easier to obtain a loan - sometimes, outstanding cash flow will alleviate other underwriting criteria like time in business, purpose of use or type of property. But, the cash flow has to be excellent.

Your business's cash flow has to be able to pay for your new debt - both the principle amount and the interest. Now, there are many structures to business debt like interest only (which I do not recommend), balloon payments, quarterly payments, etc. Still, you have to generate enough income from the business to service the payment amount. Further, not only do you have to generate enough money to pay the P & I, but you usually have to cash flow a little bit more - usually 25% to 50%.

Why? This provides the bank with assurance that your business could have a down period and still cover their loan payment.

To determine if your business could service $500,000 commercial real estate loan, begin with your net income. To this amount, add back depreciation (this is a non-cash accounting anomaly), any and all interest payments that you already make and taxes. This should be the net amount that your business has to cover your total debt service -this is essentially your earnings before interest, taxes, depreciation and amortization (EBITDA) or operating profit.

At 8% for 120 monthly payments, a $500,000 commercial real estate loan would require a monthly service of $6,067 or $72,797 per year (straight amortization for simplicity purposes). Assuming that your business does not have any other debt, you would have to, at the least, earn this amount over and above all other business costs - your EBITDA. However, most banks want to see a debt service ratio of 1.25x to 1.5x - meaning that you need to generate an EBITDA between $7,584 and $9,101 per month.

Should your business have other debt that is not being paid off with this new facility, add that amount to your new payment amount. You will then have to cover up to 1.5x of all your debt obligations.

Further, banks do 'what if' analysis on this service requirement. Take your modified net income (EBITDA) and reduce it by 10% and 20%. After these calculations, does your new modified net income still cover the original payment amount of $6,067? If not, no loan. Again, banks want to ensure that your business could survive a down turn and still make your payment.

Remember, cash Flow is king. Should your business be able to generate 2x, 3x, 4x or more in EBITDA, you or your business would have a tremendous amount of more power in negotiating the terms and rates of your commercial real estate loan.

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Types of Commercial Real Estate Loans:

First Money Purchase Loans - When you or your business takes out a loan facility to purchase a piece of property, your business is not buying the property from the bank but is buying the use of money (Termed Purchase Money). Your business then takes that money and purchases the collateral (the property) that the bank has authorized the capital for. Purchase relates to buying property not previously owned by the business or borrower.

Refinance Loans - relates to renewing the terms and rate of interest on a piece of commercial real estate the business already owns and is paying for. Refinances are great in environments where mortgage rates are falling or where the business is in a better position to negotiate better terms and rates. Further, refinances can allow businesses to change the bank or financial institution it is paying on the original loan - (refinance with a new financial organization that in turn pays off the original institution).

Further, refinances can help struggling businesses lower their monthly payments. Let's say 5 years ago, your business took out a 10 year, 8% loan for $250,000 and was paying $3,033 per month in P & I. Today, the business refinances the remaining balance of $150,000 at the same rate and a refinance term of 10 years (not the five remaining). The new payment would now be $1,820. Better cash flow for the business.

Cash Out Refinance Loans - similar to refinancing above but the business receives cash for the equity in the commercial real estate. Take the refinance example above, the business was paying $3,033 for a 10 year, 8%, $250,000 loan. Five years later, it refinances the facility at 8% for another 10 years but finances an additional $50,000 in cash on top of the $150,000 remaining balance. The new payment is then $2,427 per month and the business gets $50,000 in working capital.

Bridge Loans - As the name suggests, bridge loans provide short-term, temporary funds to allow the business to achieve a more permanent facility. These facilities usually have terms of no more that 2 to 3 months. These can be used to quickly close on a commercial real estate property that is in foreclosure or to take advantage of an immediate opportunity. Once the permanent facility is in place (which usually can take months to close) the funds are used to pay back the bridge loan.

Bridge loans usually are more costly with larger up front fees and higher interest rates.

Second Mortgage Loans - Similar to cash out re-finances outlined above. However, instead of refinancing the entire loan amount, the borrower takes a second mortgage on the equity in the commercial real estate. Should the property value be $250,000 and the business only owes $150,000, the business could take a second loan up to the difference. This could be a term loan or an equity lines of credit.

Second mortgages are usually put into second place in regards to the first purchase mortgage loan that was originally in place. Thus, should the borrower default, the first mortgage has first rights to any and all payments from the sale of the property.

Hard Money Loans - Similar to a bridge loan - but usually not issued by a financial institution or traditional lender. As the name suggests, these are hard loans to obtain and fund and are usually funded by investors looking for high returns due to the high risk.

These types of facilities are typically used when the business or owner is in distress (i.e. behind on mortgage payments) and used to get the borrower by until such time the property can be sold.

LTVs for these facilities are usually no higher than 65%, have extremely high interest rates and fees, and are only used for short-term funding.

Church Loans - and other non-profit commercial real estate loans - Non-profit organizations are unique in their financial structure and thus require unique financing. Cash flow for repayment is usually not tied to profits (thus the name non-profit) but are tied to revenues generated in the business from operations, donations and sponsors.

Commercial Real Estate Construction Loans - Constructions loans typically are two loans in one. A financial institution will complete the first facility to purchase the land for the building and then tranche funds as construction phases are completed. This first facility usually has high fees, high interest (but the borrower only pays interest on what is outstanding) and very short-terms - set to the time completion of the property. The idea behind the first loan is that once completed, the first loan will be paid off with a more permanent long-term commercial real estate loan - the second, take out, loan.

Keep in mind that while commercial real estate loans are one of the important financial transaction that most business will encounter, the benefits of your business owning real estate and having the business pay for it are immense.

Commercial Real Estate Loans are not just for the purchase of commercial real estate but can be used to further develop the business with refinance loans, cash out loans or even hard money loans.

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