Securing Financing When Your Bank Says No

TUSTIN, CA—The commercial real estate market remains competitive at every angle right now. Investors are bidding up the same properties and expanding into tertiary markets, while lenders eager to place capital and fund their loans remain aggressive on their terms. The small-balance space for properties of less than $10 million is dominated by single investors and partnerships, which often have issues that cause a roadblock with their local bank. These banks, which have developed relationships with investors over the years, typically are going to be more conservative when it comes to the transactions they participate in, and frequently are not the right lender for their deal.

While commercial lending is primarily focused upon the asset, borrower issues will still be a concern for lenders. Aggressive lenders that investors typically do not have established relationships with, or direct access to, are finding ways to make these loans work. They are responding to a number of borrower issues that have grown more common over the years, and providing alternative options to address every hurdle.

The most common hurdle that investors have trouble overcoming is a credit issue that satisifies the bank's checklist or a request that is beyond their capabilities. Past issues such as bankruptcies, short sales, loan modification and subpar credit scores will all be red flags and many times automatically disqualify an applicant. The economic downturn created a larger market for the niche lenders and private investors that fund on transactions with these issues, and there is still a large need with banks remaining conservative.

Common sense lending, as it has been coined, requires a good explanation for their issues. Putting your rental income on the poker table in Vegas, instead of making your loan payment and causing foreclosure, doesn't put you in a good position. Half of your tenants going out of business and causing a foreclosure despite your best re-leasing efforts—that is understandable. The best explanations show that the credit issue was caused by an unforeseen problem that could have happened to anyone, and helps the lender or investor feel comfortable that there is no reason it should happen again.

Borrowers will also need to provide some additional security to the lender to compensate for the risk he or she brings to the transaction. It's common to structure these loans with cross-collateralization or additional funds to reduce the LTV, or add additional partners with strong sponsorship and guarantee with full recourse in the deal.

These credit issues have been more of a problem for seasoned investors, while they have been few and far between for the growing millennial population as commercial real estate investors. The millennial generation saw their parents overextending themselves and living beyond their means, and has no interest in repeating those mistakes.

Most borrowers in this age group have good payment history, lower consumer debt and an overall heightened concern for their finances. This younger generation of borrowers commonly needs to overcome hurdles related to their financial strength and lack of ownership experience.  Business owners in this group have also additionally had to overcome a lack of operating history and a scarce balance sheet for their growing companies. These millennial investors are typically pursuing one of two paths to make a deal work: taking steps to strengthen their borrower profile with additional liquidity and assets; or securing a non-conventional loan that will allow them to fund quickly, and build their real estate resume along with their financial strength from positive property cash flow. Conventional options are then commonly revisited down the road at the right time.

The influx of foreign investors interested in placing their money in US assets has also created a higher demand for lenders flexible to accommodate these borrowers and has carved out a niche to handle that demand. These transactions require a more complete understanding of the borrowers and a heightened focus on the real estate collateral. The lender will want as much documentation on both the source of down payment, as well as any reported liquidity and assets both foreign and domestic. They will also want the foreign borrower to have more skin in the game and will reduce the LTV on the transaction. The real estate will need to have a healthy cash flow at a higher debt coverage ratio and there will be a greater focus on tenant quality and any property risk that may be present.

All transactions with borrower issues will be analyzed on their own merits. While funding these loans may be more difficult, there are ways to negotiate them that will keep the lender comfortable and make sure the borrower secures a solid loan.

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.