Unlike professional money management firms and commercial real estate (CRE) powerhouses, most individuals that have bought commercial real estate have not had the luxury of having teams of analysts, attorneys, and limitless funds to buy whatever they want. In fact, the majority of CRE owners (including multifamily, commercial retail/office, industrial, hospitality, self-storage, etc.) have built their wealth and equity by prudently saving, buying smart, being slightly contrarian (buying when there is fear, selling when there is greed), and wisely utilizing financing (debt/leverage), among other factors.
While there are literally dozens of books and resources on the topic of “How to Invest in Commercial Real Estate”, I wanted to cover five key areas around the financing of CRE, which can be a critical element in a great investment, or a poor one.
- Not all Debt is the Same!! – As a licensed mortgage broker, I feel that it is important to provide a variety of financing options to clients, as everyone is different, and each financing opportunity (purchase or refinance) is unique. Gone are the days where you simply go to your local bank for a loan on your CRE purchase. While local banks and credit unions still provide options for financing, they largely gravitate towards building relationships, and offering the best options and terms to long-standing clients, who also have significant deposits and wealth management funds held at their institution. There are a growing number of debt sources that are simply seeking a yield for their investors, or stakeholders. Life companies, debt funds, family offices, pension funds and other sources are increasingly open to lending around the US, in more markets and across more property types. So, just because your local credit union doesn’t want to lend on your CRE deal in Anywhere, FL, doesn’t mean that a debt fund from Texas won’t provide you with amazing terms that will get your deal done.
- Think Like a Lender – What do lenders want? Yes, they want to receive interest on the funds they have extended to you in a loan, but, ultimately, they WANT TO BE PAID BACK!!! Nobody wants to lose money, and lenders really, really, really, really (repeat to infinity) don’t want to lose money. So, lenders want to have multiple ways in which to get paid back. Yes, cashflow from a CRE investment is one way, but what happens if/when one of the tenants closes their doors, and suddenly there is vacancy? What happens if other tenants also fail while you are trying to replace the first? Vacancies happen, so you must present the best financial picture to a lender, to provide for multiple ways of repayment. Placing funds in reserve for these rainy days helps. Having significant other liquid assets to help cover any shortfalls can also help. Though less ideal, cross-collateralizing one asset with another owned asset can often entice a lender. Lenders generally dislike risk, or at least want to be compensated for the amount of risk they take in making a loan (higher risk = higher loan rate and/or less attractive terms). Whatever you can do to help limit the risk to a lender, do it!
- Know Your Numbers – Sure, not everyone is great with numbers, but, you can be darned sure that your potential lender (underwriter) is really good at numbers! The more you can know, and have evidence to back up, your numbers on a deal make you much more attractive as a lending prospect. For example, you are looking to buy a 20- unit apartment complex in your area. In order to present an accurate picture of the cashflows of the property, you build a detailed proforma (financial projects with assumptions, inputs/outputs), and share as part of your lending package (more on this below). If you don’t know what your rents need to be to comfortably operate profitably, then you are unlikely to get a loan- no matter how good the ‘deal’ may be. Having a firm understanding and data to support these assumptions and inputs is critical to obtaining a loan. This also informs what you may be able to pay for a property (e.g. market rents max out at $1,500/month, so I can only pay XX for this property to make the proforma work).
- Respect the Package! – Everyone loves to receive packages! Well, not quite. Lenders do like to receive complete loan packages. Many lenders have specific requirements for underwriting a loan, but many need at least the following to get to an initial credit decision and be able to issue a Term Sheet (Summary of key terms and conditions for a loan- not a commitment!): Personal Financial Statement (PFS), Tax Returns (Personal and business, if applicable), Business Financial Statements/P&L, Operating Agreement(s), Driver’s License, Budget/Proforma, and a Property/Project Summary (what’s the deal with the property, why are you buying it, etc.). Once you have talked to a lending source and received their preliminary lending package document request (like above), save these items in a folder and have them available to send over to your lender in the most complete, easiest-to-read format possible. Does a lender want to have to piece together 78 pages from 4 financial institutions’ statements to see that you have adequate assets to borrow against this property? Probably not. Again, think like a lender and make their life as easy as possible! (To give you a positive credit decision and give you a loan, which is what you are asking for).
- Get a Second (or Third) Opinion – Once you have a complete loan request package (or mostly, every lender has unique requests), you can then reach out to various other lenders that may have interest in your loan. Better yet, you could talk to an independent loan originator (like me 😉 that has a variety of lending sources, knowing the specific nuances of lender likes/dislikes. For example, one lender may really like urban office properties, while another has a bullish view on industrial properties near interstate highway exit locations. It’s not very effective to have more than a handful of meaningful, targeted discussions with credible lenders at one time. Getting 2-3 different lenders engaged can help you evaluate more than one option, and hopefully get the best terms and conditions for your specific loan needs.