Lenders Hesitant About Special-Use Properties

LOS ANGELES—While there is ample capital chasing deals at this point in the cycle, not every property is finding easy or inexpensive financing. Lenders are reluctant to finance special-use properties, like car washes, churches and educational institutions. Brian Good, a principal at Eagle Group Finance, has become an expert in navigating this difficult terrain and in securing financing for special-use properties. We sat down with Good for an exclusive interview, where he tells us why lenders are hesitant to provide funding for special-use properties, what borrowers can do to facilitate the loans and what other issues exacerbate the problem.

GlobeSt.com: Why are lenders reluctant to finance special use real estate?

Brian Good: These types of properties are very difficult to sell or lease. Meaning, the operations of the property require a real special skill. So in the event of a foreclosure, I would be faced with a substantial challenge of not only taking over the property, but running the business. 

GlobeSt.com: Are there certain types of special use real estate or characteristics that are especially difficult to finance?

Good: Schools and religious centers are difficult to finance due to the specific use and the aforementioned small pool of potential tenants. But the biggest issue is an ethical one. I don't want to be a lender foreclosing on a church or educational institution.

GlobeSt.com: What should borrowers do and know to overcome these obstacles? Are there certain types of lenders or loan types that are more flexible in working with these property types?

Good: Borrowers need to have a clearly defined plan to exit the loan. We made a loan against a charter school in northern California, but we knew prior to the loan that the borrower was going to execute a sale-leaseback, and thus the take-out was clear and this provided an additional level of comfort for us. Also, the building was re-usable for office use without much additional cash needed.

GlobeSt.com: At this point in the cycle, have these deals become easier to finance because of the ample capital in the market?

Good: In any low interest rate environment, you will see lenders reaching for yield and financing more special-use deals. That being said, these deals are still difficult to finance. These are the types of assets that are hit hard during a downturn because of they are difficult to reposition or re-lease if the tenant vacates the property. 

GlobeSt.com: How do water or environmental issues further exacerbate financing woes?

Good: Environmental contamination is the biggest potential liability for a lender. If there is an environmental issue on a property, the borrower is responsible for the cleanup, which can be an expensive process, jeopardizes the viability of the borrower's business plan, and prohibits the lender from foreclosing without risk of liability. This is true even if the borrower wasn't initially responsible for the contamination. It's important to analyze the past uses of the property and look for red flags, as certain uses present a higher risk of contamination. This is why we require a Phase I environmental report as part of our due diligence process. 

Water issues are becoming increasingly alarming, especially in California. First, we are seeing higher water bill expenses throughout drought areas, and this will only increase. We have started to make sure these increases are reflected in our underwriting. We believe that permitting for new construction will also become more expensive as City's and County's try to crack down on the biggest abusers. Hopefully a good El Nino this winter will quash these concerns.