Small Balance Underwriting Loosens, Buyers Under Microscope

TUSTIN, CA—Small balance lenders vying for West Coast deals are staying competitive by offering more flexible underwriting and terms, but having the sponsors jump through a few extra hoops to ensure they are able to guarantee the loan explains Colin Dubel, associate director with Charter Capital Group in Orange County. With cap rates for higher quality product in core markets continuing to shrink, many investors have been shifting their focus to small balance investment opportunities to keep their returns up. With that influx of capital chasing commercial deals, a handful of lenders have had to regroup to make sure they are positioned to stay in the game.

“We have been seeing lenders adapt by staying aggressive on their terms and being reasonably flexible with their underwriting,” Dubel tells GlobeSt.com. Charter Capital has had a longstanding history of placing debt for investors in California, and notes there have been some noticeable changes recently. “Debt coverage requirements have been sliding down—we're seeing deals being done as low as 1.15x to 1.20x. Properties that used to be considered a Tier II last year are now being financed with Tier I pricing.” Dubel also explains that in addition to these underwriting flexibilities, many lenders have also been offering narrower spreads, longer amortizations and even waiving some upfront costs associated with property appraisal, environmental reports and inspections.

These borrower advantages have not been limited to only core markets, as Dubel told GlobeSt.com that probably the most apparent adaptation from these small balance lenders has been their lending area expansion into secondary markets. Many investors are experiencing yield spread between core and tertiary markets become narrower, which according to him has drawn savvy buyers with lenders not too far behind. “There is more competing capital for investments these days if you are looking at properties in the Inland Empire, Central Valley and the desert—most lenders are getting increasingly more comfortable with these deals.”

The flip side of this however has been the heightened focus on borrower strength and credit from lenders to make sure there is strong backing for the loan. “They're taking a more macro-level approach lately and are more concerned about the overall financial health of their borrowers – global cash flow has been a larger focus lately.” These requirements take into consideration an analysis of the cash flow from the borrower's other businesses and investments, along with verification of reserves and liquidity. Dubel adds, “Lenders want to make deals, but they just need to be sure anyone receiving financing can handle all of their obligations and aren't overextending themselves.”

Colin Dubel and his team at Charter Capital Group expect competition to remain high between those currently in the arena, and are seeing lenders who weren't players before trying to break into the niche to capitalize on the flood of interest. “Every investor is going to have their own specific goals and desired terms. The great news right now—for a stable sponsor, you have a good shot at making that happen if you have a well-connected advocate in your corner.”

Colin Dubel is associate director with Charter Capital Group. He may be reached at colin@chartercapital.com. The views expressed here are the author's own.