I was recently on a webinar hosted by one of our lenders and I was reminded of some lending fundamentals that are well worth repeating. Every lender, no matter what type of loan, takes the same factors into consideration. They just put different weight on them, depending on who they are and what their lending objectives are.
Keep in mind that for every borrower out there looking for the best loan, there is a commercial lender looking for the right borrowers. So, in a way, getting the best interest rate and terms on a commercial loan is like winning at the dating game and finding your own special someone. It’s not just about you, the borrower, nor is it all about the lender.
5 C’s of Lending
Every loan process ultimately comes down to the lender’s decision as to whether they want to make the loan at all. This involves their overall evaluation of you as a borrower, the property you are proposing as collateral and other factors affecting the lending environment. Lenders call this the credit decision—whether to extend credit to this borrower at this time with this particular collateral.
Here is how all lenders make the credit decision—often called the five C’s of credit:
I was really interested to see that lenders still put character first. In the 1800s and early 1900s, character was the very backbone of every bank loan. If you had good character, if you were an “upstanding citizen,” if you had a solid reputation in the community, you could go into the bank and get a loan. Today, character also represents your overall behavior regarding the use of credit and money. Are you a reliable person? Do you do what you agree to do, by keeping your credit cards current, etc. Still, it’s important to know that who you are as a person still makes a difference in the private commercial lending world.
“Capacity” refers to your ability to pay the loan back. Commercial lenders first look to the ability of the commercial property (or business) itself to generate sufficient income to make the monthly loan payments with a little something left over. This is called the Debt Service Coverage Ratio. Secondly, they look to the borrower’s other assets, or income-generating properties or business for additional cash flow. In other words, how deep are your pockets.
“Capital” refers to the cash reserves and equity in the property. If you are buying or building a property, how much “skin in the game” do you have? If the loan is a refinance, how much equity is in the property? Is it going up or down?
In today’s markets, with the economy still in transition in many sectors, lenders are ultra-cautious in this area. They are looking for extra resources, additional assets, more liquidity to make them feel comfortable extending a loan.
For a commercial lender,” conditions” refers to the lending environment and the economic conditions of the property. Is the local economy strong? Is there a lot of competition for offices or apartments, or your type of product, if it is an owner-occupied property? Is the location favorable to support the property generating enough income to support this loan?
I’ve had lenders turn down deals because they don’t like the location, are uncomfortable with the demographic trends, feel an area is overbuilt, see costs as too high, or too much in flux, like lumber prices. In general, too much uncertainty makes lenders shy away.
Finally, the lender looks at the commercial property being offered as collateral. They want to understand the physical condition of the property and any negative factors such as environmental issues, zoning issues or anything else that could cause a problem.
Currently, lenders are most enthusiastic about anything housing (apartments, senior housing, assisted living, etc.) and least enthusiastic about hospitality (still.) The are also interested in light industrial, self-storage, and multi-tenanted strip malls and office buildings. Some lenders are very aggressive on repurposing commercial real estate; others prefer a fully-stabilized cash-flowing property.
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It may seem that a lender looks at just about everything in determining the qualification and pricing of a loan, and they do. But don’t be intimidated by this process. Know that in seeking a private commercial loan you are going to go “under the microscope” and be prepared to do so. Don’t make the rookie mistake of thinking you can tell the lender how you want them to make the loan, but do your best effort at analyzing your own loan package before approaching any lender. By doing this, you will have a pretty good idea of what you can qualify for and the process will go quickly and easily.
Sofia Capital Ventures is your “Concierge for Private Commercial Lending.” Cut through all the confusion by letting us help you package and present your next commercial loan request. CONTACT US for more information.