How can I buy Commercial Real Estate??
by Rodney Brown
Are you a business owner that currently rents or leases your office space? Have you ever considered buying a piece of commercial property? Or have you ever spoken with someone who wanted to buy commercial property and they started to tell you how difficult it was to obtain funding from the local bank? If you have answered yes to any of these questions and are convinced that owning commercial property is not possible, I want to assure you that buying commercial property in today’s market is not as difficult as our society makes it seem. The commercial real estate buying process can be very similar to buying your first home in the fact that you must find the right property and prove you can afford it. With so many commercial investors (lenders) in the marketplace you need a Trusted Advisor who can help you target those that are experts with your specific property and loan amount. Within the realm of commercial financing there are many variables and nuances that one must consider. Your advisor must be able to clearly evaluate the pros and cons of working with each different investor and how their underwriting guidelines will either support or hinder your efforts to own commercial real estate. As you embark on this endeavor of finding a home for your business, the primary consideration should be the type of property you want to purchase, and then evaluate what financing strategy best suits your overall business plan. Many people mistakenly approach commercial real estate financing in the same way they did their residential property with an objective to get “the lowest interest rate”! With any real estate venture, and even more critically with commercial property the most important objective is obtaining the greatest Return on Investment (ROI) regardless of any particular interest rate.
In nearly all cases of both residential and commercial mortgage financing, a quest for the lowest interest rate has a negative affect on the borrowers’ overall financial objectives. When you undertake a commercial purchase ROI is equally affected by the amortization schedule and not just the interest rate. For example; on a $500,000 mortgage with a 10 year fixed term and a 15 year amortization at 5.5% interest rate yields a monthly payment of $4,085. The same mortgage with a 25year amortization but a rate of 6% yields a monthly payment of $3,221. Notice that the same loan amount, with a ½ percent higher interest rate actually provides a monthly cash flow improvement of $864! This additional cash flow not only improves the bottom line revenue for the business owner, it actually improves his or her ability to quality for the loan! As you can see, this is just one simple validation that strategy triumphs of “interest rate” as a critical factor in commercial lending contributing much more favorably to the projects ROI.
As with purchasing a home, you want to carefully consider the down payment strategy you employ. Keeping your business liquid and out of short term debt may dictate a minimized upfront cash contribution towards the purchase of your property. With that being said you will want to find an investor provide 80% - 90% financing or (loan-to-value) while also allowing the seller of the property to hold a 2nd mortgage. There are some investors that will allow the seller to hold a 10% - 20% 2nd mortgage. This provision can allow highly qualified buyer to actually obtain 95% total loan-to-value financing and only contribute 5% to the transaction. This creative approach can be a major advantage for you the buyer and keep thousands of dollars liquid and available to run your business. As a Trusted Advisor, your Mortgage Planner would also make sure that your investor offers a competitive interest rate and flexible terms that are most favorable to your transaction.
A general approach in the marketplace is for business owners to utilize the services of local banks – especially the bank that manages their business accounts. While this practice can be convenient it can also prove to be rather limiting when it come to creativity. Most local banks provide a rather generic 3-7 year loan with 75% - 80% total loan-to-value and they amortize their loans over a maximum of 20 years and have a balloon demand feature. In other words, your choices are pretty vanilla; you will be offered a fixed rate for 3 - 7years, be required to put 20% - 25% down, have a monthly payment based on a 20 year amortization schedule and after the initial 3 – 7 year term, the full amount owed is due! This loan type forces the business owner to refinance that property at the end of this 3 – 7 year term. In a rapidly appreciating commercial real estate market that might not be such a bad thing. However, if appreciation rates are steady then the refinance cost might not outweigh the benefits at the end of the initial 3 to 7 years. Ironically, if your business has suffered any fluctuations in cash flow or economic downturn, the very same bank that made the initial loan may not be able or willing to refinance that loan for you.
A study done in late 2005 discovered that over 50% of ALL commercial loan requests were denied by local banks, over 50%!! This number may be higher if you include the requests that never make it to the Commercial Loan Officers’ desk due to pre-screening processes at local banks. Let’s look at a very typical scenario with Rocky Businessman as our example. Rocky owns a high end motorcycle repair shop and is a valued customer with his local bank for over 15 years. Rocky needs to refinance his property and get extra cash to hire 1 or 2 more technicians so he doesn’t have to spend 16 hours per day at the shop. Rocky contacts his trusted commercial specialist at his bank and submits his loan request. Rocky has sufficient income from the auto shop each month, owes $50,000 of the $300,000 property value and has credit scores in the mid 600’s. I must also add that Rocky has never missed a payment in 7years. Unfortunately Rocky receives the dreaded rejection letter from his bank officer stating that his request was denied. What was the problem? Remember, he has good credit, has never missed a payment, has great monthly cash flow and does not owe a high percentage of the property’s value. What is wrong with this picture? The problem is that the bank is no longer financing motorcycle shops per their updated underwriting model. This may seem unfortunate for Rocky but you may not feel too bad since he is just a character in our story. However, this happens EVERY Day in the real world of traditional commercial bank loans.
Another little known fact is that many local banks can require that you provide annual Profit and Loss Statements for your business. In the fine print of your loan documents there is a provision that states that if you fall below their minimum financial guidelines during a certain period you may be considered in default on your loan agreement! For example; if you have an 8 unit apartment complex and loose 1 or 2 tenants but you are still making your payments without fail, you can be considered in default on your loan.
To be certain that you have done all you can do to prevent these and other types of unforeseen disadvantages, you should engage the services of a Mortgage Planner that is experienced in financing commercial properties as well as having access to a solid group of viable investors to accommodate your individualized lending needs.
Although the world of commercial financing requires careful navigation, the rewards can be extraordinary. With the right property, a credible lending source and Trusted Advice you can be on your way to substantial business value growth in the near term. When you find yourself ready to transition to commercial property as an investment strategy or you are simply interested in owning instead leasing your existing location, make sure you find someone who is knowledgeable and equipped with the right tools to accommodate your needs. If you are currently renting or leasing commercial space, you would be well served to find out if and or what you qualify to purchase. You may find that you can easily own what you are currently renting and by doing so increase your business and personal net worth!
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