Purchasing commercial real estate is often one of the most important decisions a business owner will make. When making the decision to buy commercial real estate a business must first look at financial considerations.  These relate to the costs of owning real estate and the potential wealth that can be created.

The first three things you should consider

1) Do I feel comfortable spending the money it takes to buy commercial real estate for my business? The costs of owning real estate includes:

• Your down payment plus all the costs and fees associated with purchasing real estate
• Your loan payments your taxes and your insurance.
• The expenses associated with maintaining your property.  This would include everything from gardening to painting the property to replacing the roof.

 
2) Can I see my business using this real estate for at least ten years?  If not could I see myself otherwise owning this property for a long time?
 
There are transaction costs associated with buying and selling real estate.  In addition there is a real estate cycle that often lasts around ten years where prices can go up and down.  Over an extended period of time real estate has been known to increase in value at a rate that is twice the amount of inflation or higher.  It is important to have the ability to hold a property long enough to match the real estate cycle.  This will allow you enough profits to cover the transaction expenses

3) One must take into account the other business uses for the funds spent on purchasing commercial real estate.  Commercial real estate is usually purchased by businesses that do not feel that they need those funds to grow their business.
 
If you can afford the property without affecting your business growth and can see yourself owning the property for a long period of time, the odds are that this will be a successful investment.

There are many benefits that can come from owning commercial real estate.  The five main reasons for owning commercial real estate are as follows:

Stability
Moving is a major disruption to the vast majority of businesses.  When a business owns the place it operates out of the threat of being forced to move is virtually eliminated.  Also when you own your own building it makes sense to spend money on improvements knowing that the benefit is going to you and not your landlord.
Also consider the cost of moving and how important is a specific location important to your business.  If the cost of moving is high or the location of the business is important to your success I would advise you to be more aggressive in purchasing the property that your business occupies.

Opportunity for Appreciation
Let’s be clear “appreciation is not guaranteed”.  However for the vast majority of properties that are well maintained and are in areas of increasing economic activity there is potential for significant appreciation over time.  A property that appreciates at the rate of 5% will increase in value by 85% over twelve years.

Also the cost of renting real estate has been known to go up at a rate that roughly tracks the cost of real estate.  Often your total monthly payments and costs of owning your own building could less than the cost of renting the same property within ten years.

Freedom from Rent Increases
One of the major complaints that I have heard from businesses is that they build a successful company at a good location only to see a significant rent increase at the end of their lease.  I have also seen many businesses forced to close due to rent increases.

A large rent increase can be particularly devastating to companies that have put a significant amount of tenant improvements into the property or feel the need to stay at or near their location for other reasons.
Remember the tighter the real estate market the larger the potential rent increase

Real estate is one of the few assets that you can use to get a loan – At least at reasonable rate.  The hardest time to get a loan is when you actually need the money. Having real estate to pledge as collateral might be the difference between getting a loan and not getting one.

Retirement
Most of us will retire one day.  The rent that you collect from your property can make your retirement more comfortable.

The decision to buy real estate is a big one. With that in mind I will leave you with one final thought.
“We work to make our living; Wealth is created through the ownership of assets.”

If you have any questions regarding commercial real estate loans please give me a call.  I am actively working on conventional commercial real estate loans and SBA loans.  I have over a quarter century of experience and would be pleased to see how I could help.


Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com

For most businesses there are a couple of ways to raise capital.  One is by offering equity, the other is receiving loan.  

Offering equity is giving an investor a share of the future profits of the organization in exchange for that investor providing capital.  An example of this would be the stock market. Start-up companies often give equity to investors because their capital needs can exceed the amount of money they could reasonably hope to borrow.  Equity can be structured many ways from buying stock, to a friend buying into another’s business.

The benefit of offering equity is that if the business fails the investors lose their money and there is no remaining obligation.  The downside of offering equity is that if the business succeeds then the money paid to investors will eventually far exceed the amount paid for a similar amount of capital from a borrowed lender.

Most small to medium sized businesses that seek capital try to get a loan from a bank as opposed to offering equity in their company.  However, the downside of getting a loan is that the bank expects/demands to get its money back.  It will be a problem for someone if the business does not generate the cash to pay back the loan.

Since a bank’s profit on a loan is limited to the interest paid and their potential loss can be up to the amount owed, they have to be very careful when making a loan.  As a result, most banks will look for at least two ways for the borrower to repay his loan.

Having more than one way to repay the money that a company is seeking is one of the main differences between being able to be a borrower or having to offer equity instead.

One of the first questions that a bank will ask a borrower is, ‘How are you going to pay the bank back if your business does not succeed as well as you would like it to.’  If a borrower wants to get a loan there needs to be a good answer to that question.  If this question can’t be reasonably answered then instead of looking for a loan one should be looking for investors.

Often times some sort of collateral is used as the secondary source of repayment. For banks that make real estate loans, it is the property that serves the secondary source of repayment.  For this reason banks try to limit the loan-to-value it provides on a transaction to a level that will allow it to recover loan funds in the event of a default.

The other thing that banks look for when deciding to make a loan is how much the borrower’s own funds will be put into the transaction.  The unofficial term for this is “skin in the game.”  A bank wants to know that the borrower has something to lose if there is a problem with the loan.

Having the ability to put your own funds into a transaction is something banks look for in a borrower.  Without some skin in the game, you would be looking for equity.

Cash flow – I discussed cash flow in a previous e-mail. Suffice to say a borrower will have to show the ability to pay back a loan based upon tax returns or accountant statements.

Now how does the SBA fit into the bank vs. investor matrix?

The SBA loan program is designed by the U.S. Government to assist small businesses in obtaining capital that the conventional lending market cannot provide.  The SBA does this by putting the full faith and credit of the U.S. Government behind a portion of the loan.  The loan guarantees that the U.S. Government provides for commercial loans often act as the secondary source of repayment for a bank.

The loan program does a couple things; The SBA loan program allows the bank to provide a much higher loan-to-value than would otherwise be possible.  Also, in some cases, this financing can be at below market rates.  As a result, I strongly recommend that owner-users of commercial real estate at least look at the SBA loan program when considering financing.

If you would like to talk about any sort of lending issue I would be pleased to speak with you.  I can assist you or your clients with a wide variety of loans, and not just the SBA loans.  Please call me even if you have a question about a loan that I am not part of.  I have almost 30 years of experience and am always happy to help.


Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com

“Private Money”, also referred to, as “Hard Money,” is a source of capital for real estate that does not get as much attention as traditional commercial lending.  However, Private Money occupies an increasingly important niche in today’s market.  As a result it is important to better understand what is going on in this industry and how it might affect you and your clients.

A Private Money lender provides loans to individuals and other entities purchasing or refinancing real estate. This financing is available for a wide variety of properties including those that traditional lenders would not favor.

Private Money lenders use their own money, money that they obtain from investors, and lines of credit from other lending institutions to make loans.  What they try to offer their investors is a higher-than-average rate of return on their investment with a controlled amount of risk.

The way these lenders provide the above average returns is by charging a greater interest rate than charged by conventional lenders. To avoid risk they try to limit the loan to value and/or qualify the borrower. There is a wide range of interest rates and fees being offered – much of it do to the different risks associated with each loan.

Traditional lenders look to the cash flow of the property and/or the cash flow of the borrower to make a lending decision. They look at the value of the property as a secondary source of repayment. A source of repayment they would rather not deal with. As a result, traditional lenders are less likely to work with a borrower or a property that has financial issues.

Private Money lenders are also known as collateral backed lenders.  The loan to value and ease of getting out of a property are their primary concerns when looking at a loan. The current cash flow of the borrower or the property is not as important to them. However, Private Money lenders are often more aggressive when it comes to foreclosing on borrowers who default on their loan.

For the Private Money borrower this typically means that the up-front loan fee and the interest rate will be greater than that of traditional lending. Before getting involved with a Private Money loan a borrower should seriously consider why he would want to use such a product.
 
Good reasons for obtaining a Private Money loan include having a plan to increase the value or income of a property or to get quick access to capital in order complete a purchase at a below market price. 


Some examples of these are as follows:

1. The purchase of a property that is in a state of disrepair. For a traditional lender this would include a construction loan which requires significant documentation. Often, the items needed by a traditional lender to close a loan on a property such as this will not be available prior to the completion of escrow.
   
2. Rehabilitate your own property. The money will come directly to you and you can spend it on the rehabilitation as you see fit. This avoids the site inspections and other requirements that may be imposed by traditional lenders. A Private Money loan will sometimes sit in second position allowing a borrower to keep an attractive first loan.
   
3. Get someone out of your life. Sometimes things just don’t work out. There are times when one partner wants cash out of a property and the timing for a new loan is not right. Private Money, either as a new first loan or a second loan is the appropriate alternative.
   
4. Money is needed quickly in order to close a transaction. Some of the best deals available to a buyer are as a result of the seller needing money very quickly. Typically, a traditional lender will not be able to respond quickly enough for a transaction to be completed within the seller’s time frame.
   
5. Your income is not documented. For a traditional lender, tax returns or audited financial statements are necessary to determine cash flow. If you do not have these, your chances of getting a conventional loan are slim.
   

It is important to remember when dealing with a Private Money loan that a plan is needed to get out of that loan prior to accepting the funds. A significant percentage Private Money loans end up with the lender taking back the property that is used for the collateral. These are properties that should have been sold prior to getting that loan. Getting a Private Money loan based on the hope that one’s personal economic situation is going to get better is a recipe for disaster.  

The other thing that is important to remember is that the rates and terms for Private Money loans vary to a much greater extent than conventional loans. Various Private Money lenders have different risk appetites and price their money accordingly. Depending upon the lender and their risk appetite, interest rates can range from 8% to 15% and the loan fee can range from 2% to 6%.

Therefore it is important to match your Private Money request with the right lender. Sometimes the higher rate and fee is justified and sometimes it is not. It has been my experience that, often, a borrower who needs a Private Money loan goes with the first lender they can find. This can be very expensive.


So if you are in a situation where you feel that you might need a Private Money loan; what should you do?

1. Make sure that this loan is part of a greater plan for your real estate that includes getting out of the Private Money loan at the end of the plan.
   
2. If you already own the property for which you are considering getting a Private Money loan for, think about selling that property as an alternative to getting the loan. This is especially important if you not see an easy way back into conventional financing.
   
3. If you do not know much about Private Money lending consider hiring a mortgage broker who does have knowledge of Private Money lending and who can, and will, advise you of the best alternative for your current situation. This will help you avoid wasting time dealing with lenders who want not to give you a loan in the first place. More importantly it can save you from paying significantly more for the loan than you would otherwise have to.
   

One last important point when it comes to Private Money lending.

One of the many differences between a traditional lender and a Private Money lender can be reflected in the escrow documents. Bank loan documents tend to be somewhat similar and there really is not that much negotiation in reference to the documents.

Private Money loan documents can vary widely from lender to lender. While the vast majority of Private Money lenders are honest, some of them do stick things in the loan documents that were not previously clear to the borrower. Furthermore, Private Money loan documents are usually easier to negotiate than bank loan documents.

As a result it is very important that you review your loan documents prior to signing them. If you have questions, get legal advice. Under no circumstances should you sign any loan documents that you do not understand. Mistakes and miscommunication on loan terms are somewhat rare, but when they do happen it often can be devastating to the borrower.

If you have questions about Private Money lending or any other commercial real estate question please do not hesitate to contact me.

Contact Bill Hand to learn more about Debt Coverage Service Ratio and how it applies to commercial real estate financing. 

Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com

There are a large number of both bank, and non-bank lenders, willing to make loans at a price, the price being the interest rate that is charged.   One of the most important factors in determining the interest rate is the financial strength of the borrower. 
 
Financial strength is often shown as the difference between the amount of money that the borrower is making and the amount of money that the borrower is spending.  This is known as the Debt Coverage Ratio.
Determining financial strength is typically done by reviewing the borrower’s tax returns, personal financial statement and credit report as well as related documents as needed. From this information the borrower’s “Cash Flow” can be determined. Please note that unreported income is not likely to be counted.

A loan with an extremely financially strong borrower and a good multi use property in a non-blighted major metropolitan area can get an interest rate today (depending upon the terms of the loan) that will most likely never be seen again for decades. 

If a borrower has bad credit and especially if there has been a foreclosure the opportunity to get a good loan is limited.  Some banks will consider these loans if there is a good story behind the financial difficulties with the borrower doing his best to pay back his obligations.  However that borrower had best be currently making money and don’t expect the best interest rate compared to other commercial lender.

The lenders that work with people who either have bad credit or do not show enough cash flow (via tax returns) to cover the monthly payment are known as private money lenders.  These lenders make loans based on the loan amount as compared to value of the property.  This is known as collateral lending and due to perceived risk the interest rates are much higher than cash flow lending.

Most people have the financial strength somewhere between a strong and a weak borrower and have no idea of the type of loan that they are qualified for.  Furthermore everyone wants the best rate and terms possible.  

Where the desire to get the best loan possible becomes a problem is when a borrower thinks that the terms that he can get are better than what he actually can get.  This misconception can lead to massive amounts of wasted time working on deal s that never have a chance to happen and broken escrows.
As a real estate professional who basically sells your time and expertise it is important to know what type of borrower you have.

So how do you find out what type of borrower you have?

At the very beginning of the sales process insist that you buyers put together the following information:

1. Last three years tax returns, both business and personal  complete with all schedules and company provided K-1’s.
   
2. Please fill out a financial statement that is very similar to what I have attached.
   
3. A copy of their credit report that shows the borrowers continuing obligations as well as their credit report.

With this information you would have a very good start in determining what type of loan that your borrower would qualify for.  This will allow you to set the appropriate expectations and avoid headaches during the lending process.

Contact Bill Hand to learn more about Debt Coverage Service Ratio and how it applies to commercial real estate financing. 

Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com

Debt Service Coverage Ratio (DSCR) otherwise known as the debt coverage ratio (DCR) is one of the main tools that lenders use when deciding whether to make a particular loan.

A simple example of how DSCR is calculated is as follows:

=  Earnings before Depreciation, Interest / Taxes
    Total Debt Service

A ratio that is above 1/1 would show that the borrower has excess income to meet continuing obligations plus the payments any loan that the lender is contemplating giving. A ratio below 1/1 would mean that there is not enough income to support the proposed debt along with existing obligations.

The vast majority of lenders describe themselves as cash flow lenders. This would include pretty much all banks, credit unions, life Insurance companies, etc. In order to get a loan from a cash flow lender a ratio in excess of one is normally required. 

Most borrowers who find themselves with a DSCR below one, end up with a private money loan. This is often called "Hard Money,” and rightfully so as the rates and fees are significantly above that of traditional lenders.

Different banks have different DSCR requirements and depending upon the specifics of any transaction the required DSCR could be higher or slightly lower. Generally speaking, those lenders that offer the lowest rates would like to see a higher DSCR. Not always, but in general the lower the rate the more stringent the cash flow requirement. It is a reasonable assumption that most national banks look for a DSCR approximating 1.25/1 or higher.

Occasionally, a SBA lender will consider a loan to a borrower who has existing financials that show a DSCR below 1/1 if the borrower has a reasonable projection showing the ability to make the loan payments. An example of this would be a business that purchases a property to expand their existing facility. The projected income to pay the loan will come from the efficiency of the new location and would not be reflected in historical financials.


Why this is important
The debt service coverage ratio impacts a borrower's ability to get a loan at reasonable rates and terms. Private money loan rates can be at least three percent higher than conventional rates and usually significantly more.


What you can do about it
When looking at the above ratio for DSCR, the denominator (part that is below the line) consists of total debt service. The smaller that number is - the greater the loan that you will qualify for from a cash flow lender.

1. Prior to applying for a loan, pay off all your credit cards. Banks often take a percentage of your total balance and apply it to your total debt service. This amount varies from lender to lender, but can be from three percent to five percent of your outstanding balance. For example, if you owe $10,000 in credit card debt, a lender would assume $300 to $500 in monthly payments.
   
2. Buy or refinance your commercial real estate before you make any purchases that require monthly payments. Every dollar in monthly payments that a borrower has is added to the denominator.
   
3. To the vast majority of lenders the most important year for the DSCR is the last year for which they have tax returns or audited financial statements. So if you are planning to purchase or refinance commercial real estate in 2014, you want your 2013 taxes to look good.
   

 
Simple example of how this would affect your ability to get a loan
Let's say a major bank is looking at making a loan on your property at about a 6% annual interest rate for a thirty year term. 

You have $15,000 is credit card debt and you just leased a nice car with a $550 monthly payment.

A lender could assume a monthly cost to you for the credit card debt to be $450 per month and with the $550 lease payments you have $1,000 monthly expenses.

If you waited to lease the new car and used your excess money to pay off your credit card debt you would qualify for an extra $150,000 in financing.

If you have any questions regarding commercial real estate loans please give me a call. I am actively working on conventional commercial real estate loans and SBA loans. I have over a quarter century of experience and would be pleased to see how I could help.


Contact Bill Hand to learn more about Debt Coverage Service Ratio and how it applies to commercial real estate financing. 

Bill Hand
Pacific West CDC
415-221-4263
bhand@pacwestcdc.com