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Understanding commercial mortgages

Welcome to the world of commercial mortgages. This brochure is intended for people who are venturing into the world of business investing. It is written to introduce you to some of the differences between residential loans and commercial loans, and hopefully help you become more profitable in your quest to diversify your income through commercial property. I will do my best to teach you the who, what and why of business loans. A big part of your success as a business investor is choosing the right mortgage for the property, so it makes sense to learn about business mortgages. What follows is the straight scoop on commercial mortgages. Knowledge is power; my aim is to give you that exact knowledge-knowledge. And so, let’s begin.

WHO?

Who lends the money in the commercial field? This is the first and possibly the most important difference between commercial and residential. Yes, you apply to a big lender or bank or some financial institution every time you make a home loan. But money is not really slow for that institution. It’s for a few days. But eventually they sell the loan to FNMA or FHLMC and fund the money. They only retain service rights. Fannie or Freddie then pools all of those loans together and passes them on to investors as mortgage-backed securities. In other words, the bank is not really lending its own money. Not so in commercials. In the commercial field, most of the loans are made by banks and it is their own money. They take the money on deposit with them and lend it to different companies. There is no giant like FNMA waiting to finance them. If that loan defaults, the bank is stuck unless it can sell the property for a profit. Because of this, they are much more demanding than they would be with residential loans.

But that is not all. 80% of all businesses fail within 2 years and if someone falls into financial difficulties, he will let his business investment go before the house his wife and children live in. Business loans are investment loans and you know very well that the rules are stricter for investment loans. Because each property is completely different, business dealings are not difficult or fast. There are no standard rating ratios here. The property is more important than the borrower. You can have a great borrower but have bad property and no one will buy the loan. A loan officer called me crazy because his client’s loan was denied by our underwriter. His message went something like this: “I have a guy with perfect credit, great income, $450,000 worth of property, and all he wants is a small $300,000 cash loan. You must be an idiot if you can’t get this loan.” . ” So I took out the loan, and much of what he said was true. The borrower’s credit was perfect and his income was good, except on the property. The property itself was losing money. His borrower told him the property was worth $450,000 but based on cash flow I wouldn’t appraise more than $150,000 (more on appraisals later) No one is going to lend $300,000 on a place that’s only worth $150,000!

When talking to him, it turns out that he has been trying to get approved for over a year! Business loans are deal specific. Understand that the bank is lending its own money and that they will be very picky about what they lend. The good news is that if the deal is good, there is more than enough commercial money available: banks WANT to lend. They are just more careful when it comes to their own money.

WHAT?

What takes so much longer to close on commercial deals than residential loans? Rare is the business loan that closes in less than 1 month, and the rate on those quick-closing offers is much higher. Small business loans usually take 2 months and large business loans can take up to 4-6 months or longer! Many factors go into this: the appraisal, the broker itself, the title, and especially the borrower. Let’s start with an evaluation. It will rarely be ordered before the loan is approved and the borrower has committed. This could be weeks after the agreement. Once ordered, the appraisal for a commercial property typically takes a month and could be longer if the property is large and mixed-use. That’s because the land under commercial property is only part of the equation. Ultimately, the value of the properties will be determined by your cash flow. The appraiser of a commercial property has to obtain the financial data of the property and compare it with similar properties in the area. If my apartment complex is 80% rented and the average complex in the area is 85% rented, it will affect my appraisal. The way the property has been managed is important. How quickly the appraiser can get that information is important. The appraiser must often contact an owner and obtain information directly from them. It’s not as easy as pulling up a listing from MLS. Don’t trust someone who says they can convert a commercial appraisal into a residential appraisal in less than a week. That person does not understand commercial.

You should be careful when choosing a broker or banker to help you. A broker can often drag the file because he doesn’t get the necessary information in advance. If my apartment complex has 30% vacancy compared to most places that have 25% vacancy, then I need to explain that and have a business plan ready that explains how I’m going to change that. Most brokers will submit a deal with a completed home loan application, credit report, and two years’ worth of tax returns and think the loan can be approved. Then when asked for the things that are actually needed: 3 year operating statements, business plan for the property, etc. they resist getting it. Loan will never be approved based on 2 years tax returns and credit report alone. Why? Because ownership is the most important factor. However, if you get the right documents in a timely manner, your loan will be processed much faster and have a chance of being approved. Because commercial property title often involves environmental and zoning issues, it can also take 30 days. A 10 million dollar deal was hung on environmental issues for 3 months! The more complete the information up front, the faster you can close.

Finally, the other great ballast in commercial closing times is the borrower, and I am not referring only to obtaining documentation. It is important to remember the terms, if you have a contract, you have 45 days of subscription and appraisal from the moment you stop buying, you provide everything and you commit to a lender. YOU CANNOT PURCHASE A BUSINESS LOAN UNTIL THERE ARE ONLY 30 DAYS LEFT! If you do, you’ll end up with a high rate, a quick closing loan, or asking for an extension and risking losing the entire property if the seller gets another offer. A property that will earn you thousands of dollars in profit in a month above 1/8 percent of the rate is not worth losing, which can save you $50 a month! Don’t be wise with pennies and foolish with pounds. Understand time frames and trade appropriately.

WHY?

WHY invest in commercial real estate then? If lending criteria are stricter and deals take longer to close, why not stick with residential investing? Because commercial properties require much less maintenance and are properly managed. You can rent them on triple net lease and have clients do all the repairs. Usually this is a very well built large building and not a house with children. These properties are not used as a residential home, people do not live there, and therefore the useful life of the property is extended. And even if it’s a multi-family property where people live, you have diversified income. An apartment complex might have 20 units, and therefore if a tenant moves out, they still have another 19 rentals left. The commercial mortgage is actually your best friend because we take vacancy rates into account when underwriting the file and make sure the property is still cash flowing EVEN with average vacancy rates for the area. YOU KNOW your ROI and risk is mitigated. PLUS, you get all the normal benefits of investing in Real Estate: appreciation, but you can depreciate the asset in its returns, stable money with minimal effort, and inflation protection that’s hard to beat.

Investing in commercial real estate can be lucrative. If you’re a business owner, buying a property and locking in your payments instead of rents that increase every year is a smart move. Either way, commercial real estate is a smart choice. Making the right decision on your mortgage can make the difference between a good investment and a great investment. Hope this helps clear up some commercial mortgages. For more information or assistance, please do not hesitate to call the representative who sent you this report.

Best regards!