5 Tips to Commercial Loans
1. Find a Good Mortgage Broker
There are many different commercial loan programs out there, and finding them, let alone understanding them fully, can be complicated. Engaging a professional to do the shopping for you and then lead you through the process can be valuable, especially for first-timers, says Adam Petriella, senior director of Marcus & Millichap Capital Corp. in Los Angeles.
“A mortgage broker can shop the market, and a good one should know the banks that can fill your need,” he says. “You need someone to help. A good commercial mortgage broker will help you determine what’s a good mortgage or loan.”
Engage your mortgage broker in the property shopping process, as well, says Edward Craine, vice president of the California Association of Mortgage Brokers and CEO of Smith Craine Finance in San Francisco. Because commercial loans take into account the income that the property will make, lenders typically use a debt-service coverage ratio (DSCR) to determine whether the property has enough income to sustain itself. A mortgage broker can help you determine how much income a property needs to have before you decide to buy, Craine says.
2. Choose the Right Lender
There are two basic types of banks that you can borrow from: investment banks or commercial banks. Investment banks offer conduit loans, a $2 million-or-more loan in which the “conduit” packages many single loans together and sells them to institutional investors as mortgage-backed securities, i.e. bonds, Petriella adds. Conduit loans have a more diligent acceptance process, have high pre-pay penalties, closing costs and fees, but the interest rates are significantly lower. If you’re going to hold on to the property for seven years or more, then conduit loans might be “worth a look,” he says.
Commercial bank loans with higher interest rates, on the other hand, are the more conventional route. Because conventional bank loans are more flexible and the degree of diligence isn’t as intense, these loans are usually the way to go, Petriella says. “If tenants are going to be there short-term, if the building needs work, if the property is older or you’re building additions, then you should choose a commercial bank,” he says.
There are also different lending institutions that specialize in particular types of property and what it will be used for, Craine says. For example, there are lenders who will grant loans to industrial properties and those who won’t, he says. There are also lenders who specialize in lending to owners who want to occupy the space they are buying for their business needs.
3. Know What the Lender is Looking For
Before you even look for a property, you need to know what lenders are going to consider before they decide to give you a loan. Craine recommends going to a few different local banks and/or mortgage bankers to understand what they are going to be looking at when considering you for a loan. It also will help in determining what you can afford, as banks all have different maximum loan-to-value ratios, just one aspect in determining the size of loan you will get, he says.
Petriella views what lenders take into consideration as a three-legged stool; they will scrutinize the borrower, the property and the tenants of the space. He says the bank will analyze the borrower’s personal credit, as well as the business’ health, if applicable. Property issues they will consider include condition, past maintenance or renovations, location, type of construction, past use, zoning and any environmental issues. Perhaps most importantly, Petriella says, the lender will analyze present or potential tenant matters, such as the lengths of leases, rent amounts, probability of tenants staying, demand of property and vacancies in the surrounding area. He adds that lenders usually ask for a list of all capital improvements to the property in the last five years, and all the expenses and income of the property for the last 24 months.
The bottom line is that banks want to make sure you will have a positive cash flow from the property, Craine says.
4. Work with a Lender Who is Knowledgeable and Explanatory
The lender should explain all aspects of each eligible loan to you. Work with a lender who will show you a side-by-side comparison of the key points of the loan, Craine says. These points should include the interest rate, closing costs and prepayment penalties, as well as the unique aspects of each loan. Craine’s company puts together a spreadsheet that compares up to six to eight loans side-by-side and explains them to the customer.
“It’s also very important to have someone who can explain the loans and the terms of the offer being made,” he says. “They should explain to you the long-term financial implications of the loan you’re taking out, and the financial advantages and disadvantages of different loans.”
5. Ensure Information is Accurate
All information you provide to the lender should be accurate, easily verifiable, organized and clear. “Lenders are busy, and they want the information clean and organized and accurate the first time,” Petriella says. “You’re doing yourself a disservice if you’re sloppy. Second chances are very difficult to get.”
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