This article was originally published in 2013. It is the result of what is now 10+ years in commercial lending. In light of the economic turndown resulting from the COVID-19 pandemic, lenders are even more conservative toward risk. We hope you will take these lessons to heart.
10. Lack of experience with commercial property
Sofia Capital Ventures often gets requests for commercial loans from people who are beginning to invest in commercial real estate. A loan request may be rejected for lack of experience. If you are new to investing in a particular asset category, the best thing you can do is partner with someone more experienced in developing and/or managing this type of property. There are any number of “gotchas” in the construction and day-to-day operations of a property. An experienced manager is your best insurance against fraud, lazy employees, costly expenses or missed income opportunities.
9. Too much other debt / too highly leveraged.
Occasionally, we get a request from an experienced investor who is looking to either refinance an existing property or add another property to his or her portfolio. The challenge here is that they are often too highly leveraged. All of their existing properties have mortgages at the maximum loan to value and there is very little additional equity that might be available to provide back-up cash flow or additional collateral to the lender. Lenders see this as a risky position because if one property develops a problem, it could potentially cause the entire portfolio to be at risk. In today’s market environment, extra liquidity, additional equity and increased cash flow can make the deal work.
8. Not being prepared with the right paperwork
If you own a commercial property, you must keep separate books on each property you own. Period. End of conversation. We’ve seen a number of investors who hold property in their own name, don’t pay themselves to manage the property, don’t keep records of their tenant leases, don’t charge themselves rent if they occupy part of the property, and co-mingle funds with their personal accounts. When it comes to commercial loans, lenders want to see a clear and accurate history of the property’s performance. They need to know that the property alone can support the costs of servicing and repaying the debt. If you cannot provide historic profit and loss statements, rent rolls, details of capital improvements, as well as your own personal financial statements (excluding the property being refinanced), then you will likely not get funded.
7. Insufficient cash flow from the property
Another big mistake that commercial property owners make is overstating their income from the property and understating the true expenses. Lenders want to see that the property can support the amount of debt the borrower is seeking. Pretty simple. They do this by calculating the Debt Service Coverage Ratio (DSCR.) DSCR = NOI / Annual Debt Service. (NOI = Net Operating Income.) The two biggest mistakes we see here are i) not subtracting a vacancy allowance from the Gross Rental Income; and ii) not adding a property management fee when you manage the property yourself. Change these two numbers and you may discover that your property actually doesn’t cash flow to cover the amount of debt you are seeking. Look at it from a lender’s perspective, not your own.
6. Asking for too high a loan amount
Some borrowers have unrealistic expectations about how much debt they can put on a commercial property. Unlike residential property, where you can usually borrow 80% of the property value in first mortgage, commercial lenders will loan 65%-70% LTV (loan to value.) If you are buying a property, some commercial lenders allow the seller to carry a 2nd mortgage on the property; however, they require the borrower to have at least 10% “skin in the game.” Another option, for owner-occupied commercial properties is SBA guaranteed loans that can go up to 90% LTV. However, for the vast majority of commercial property owners whose income is generated by tenant leases, you are limited in the amount of money you can borrow. Asking for more than the maximum LTV will cause your loan to be denied.
5. Fundamental lack of understanding of lending parameters
Ok, Lending 101. Sofia Capital Ventures facilitates loans from private sources. Unlike banks that bundle their loans and sell them on Wall Street, we work with portfolio lenders. Their first concern is the monthly loan payment. Does the property have sufficient cash flow to handle the monthly debt service? Their second concern is the property’s ability to repay the principal over time. If you, the borrower, come to us and try to sell the merits of the deal based on how great the property is, how terrific you are as a person, or how much interest you’re willing to pay, you’re barking up the wrong tree. The lender is not very interested in these things. Know your lending (and borrowing) basics!
4. Not willing to pay lender fees
We get lots of prospective borrowers coming to Sofia Capital Ventures and stating up front, “I don’t pay up-front fees.” We don’t charge up-front fees, either. However, someone must pay for the up-front expense of underwriting your loan, including appraisal costs, market reports, credit reports, background checks, legal and title work, and the third-party fees to the people who do all this work. Lenders underwrite hundreds of loans that never get to funding because the borrower has misrepresented some fundamental aspect of their deal. Lenders expect you, the borrower, to put down some money in advance of loan closing to show the seriousness of your intent to actually close the loan with them. They call this a due diligence fee. Banks may charge you 2-3 points up front and require you to keep a sizeable amount of funds on deposit with them for the life of your loan. So, if you want to get funded, quit telling lenders what you will and won’t do.
3. Wanting the lender to conform to your terms
This leads me to the third most common reason why commercial loans don’t get funded. I cannot tell you how many “borrowers” come to us with their list of terms of what they are “willing to pay” to get a loan on their commercial property and they are just not willing to budge off their deal points. Let me tell you something, folks—it’s still a lender’s market! Even though commercial real estate is recovering momentum, there are billions of dollars being invested in commercial mortgages and lenders still control the deal flow. After all it’s their portfolio. Remember the “Golden Rule.” He who has the gold makes the rules!
2. Asking the wrong person to get the loan for you
Probably the second biggest reason that we’ve seen perfectly good commercial loan request go south and never get funded is taking the deal to the wrong person. Generally, this person represents themselves as someone who can get you a commercial real estate loan. Ask them a key question, “Are you direct to the money?” We get a lot of intermediaries bringing us deals. Sometimes they have a second intermediary who brought them the deal. Sofia Capital Ventures charges 1-2 points at closing as our success fee. We are direct to lenders and we pre-underwrite deals for them. Lenders usually charge 1-2 points origination fee as part of their compensation for getting you the loan that you need. If a broker who is not direct to a lender brings us a deal and they also want 2 points (or more) and their intermediaries (the person you brought your deal to) also charge you 2 points, do the math! By the time the deal gets to the actual person who can actually make the loan happen , it has gotten so expensive for you, the borrower, that you will never want to close on this loan. Similarly, don’t bring your loan request to your accountant, your attorney, your neighbor, your friend, or someone you heard about from some other source. Bring your loan to the people who can actually get it done for you!
1. Going to the wrong lending source
The number one reason why, in our opinion, commercial real estate loans get denied is that they are not brought to sources that can actually fund them. Most often, if your deal has been turned down, it is likely that you brought it to a bank, credit union, or other mortgage lender, that a) doesn’t do commercial loans; b) doesn’t do your particular type of loan; or c) has no room in their current portfolio for your loan. Banks, etc. are regulated by FDIC, FSLIC, NCUA, Fannie Mae, Freddie Mac, etc. These oversight agencies regulate not only the rate and term that banks can offer you, but also the mix of loans they can hold on their balance sheet. Here are some mismatches we’ve seen – stand-alone restaurants (too many in the lender’s portfolio); rural apartment building (not enough population density for major banks); depressed economic area (most banks not lending there.) Other reasons banks won’t lend to you no matter what—property underperforming; need a discounted payoff; wrong asset category (e.g. no car washes); IRS tax lien issues; property taxes in arrears; vacancy rate too high. In other words, if your property isn’t “perfect” banks are more likely to turn you down.
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Sofia Capital Ventures is “Your Concierge for Private Commercial Lending.” We work with a select group of private commercial lenders. These lenders are portfolio lenders. More importantly, they are real people. They look at the merits of each deal and can usually come up with a loan proposal that meets the requirements of your deal. They may propose a workout. They may propose a bridge/conventional package. They may propose a JV or equity partner. Whatever the situation, SCV will advise you, up front, without fees, as to the strengths and weaknesses of your deal and what you might be facing in order to solve your particular problem. Give us a call! We’re here to help you.