Ask a Broker (And Other Commercial Real Estate Experts)
If you’re just starting out as a commercial real estate investor or business owner that wants to own their own property, some of your first questions may have to do with getting financing. While you can certainly raise capital through private investors, insurance companies, and pension funds, getting a commercial real estate loan from a bank or independent lender is among the most common ways to go. In order to help you understand how this type of financing works, Eddie Blount with Pinnacle Financial Partners in Durham shares his perspective from the lender side of the equation.
Q: If I am a new investor, or new potential property owner, and I'm coming to you for the first time, what would you tell me that you’re looking for when deciding whether to give me a loan?
A: The first source of repayment is what the bank looks at most heavily. Most banks are very comfortable with triple net lease properties where you have a good tenant that is basically underwriting the property themselves – even more so than the borrower. If you've got Google coming to town, and they are signing a 10-20 year lease for office space, that's going to be a pretty exciting prospect for a bank and for a buyer.
The same is true for really any of the national retailers that have a demonstrated history and have or are going to be signing a long-term lease. Those are fairly easy to get done. Banks are pretty competitive in trying to book with those sorts of loans. It gets a little more difficult if you've got more of a mom-and-pop type tenant. The bank's going to look at whether there's a good history there and if the business has been around a while and is seasoned. If they've been paying rent for five or 10 years, that's going to be more attractive than somebody who may need a brand-new lease. The bank may be a little bit more hesitant to do something there, or they may lower their advance rate and do a 50% or 60% loan.
Q: What other factors are considered when deciding whether a loan will be given or what the amount of the loan will be?
A: Since I've been in banking almost 30 years, it used to be that we did a lot of our commercial property underwriting based on the loan to value ratio. That’s the amount of the loan compared to the appraised value of the property. If the appraisal is $1 million dollars, then we might agree to do 80% of that and give you an $800,000 loan. Now, loan to value is required by the federal government, and there are regulations limiting the amount that can be loaned in order to better control risk to the borrower.
We also focus very heavily on debt service coverage, which is a gauge of the cash flow available to pay debt obligations. The cash flow from a building that just appraised for $1 million dollars may not necessarily support that $800,000 loan. Because of that, banks are going to look at both debt service coverage and the loan to value ratio when determining whether a loan can be given and if so, what the amount will be. Previously, it seemed like banks were focused primarily on loan to value and then debt service coverage came up later in the underwriting.
Q: Can a commercial real estate loan be made to an individual or does it have to be for a business entity?
A: It could be made to an individual. A lot of times people choose not to do that because they might be afforded some liability protection by doing it in an LLC, but if they want to own the property in their own name and operate it in their own name, I don't think the bank's going to have a problem with that.
In fact, it’s important to know that if the borrower does want to put the loan under a different entity, such as an LLC or a partnership, more than likely the bank is going to require the individual or individuals to sign some sort of personal guarantee. So, they may shelter themselves from litigation by doing it as a business entity, but banks are normally going to want to drill down to find a living entity that's going to guarantee the loan. In a large group, that guarantee may be able to be split among different people.
Q: What are typical commercial property loan repayment schedules?
A: It’s usually anywhere from 15 to 25 years depending on the property type and the condition of the property. If you have a property that's 30 years old, you're probably not going to get a 25-year amortization on that unless it's been renovated. If you've got a brand-new construction, I would say a 25-year amortization is very likely, but the bank is not normally going to do a fixed rate for that entire period and will probably have a balloon payment built in at the end.
Q: In addition to triple net, what are the other types of properties that seem to be the best bets right now when it comes to getting a commercial real estate loan?
A: Industrial properties are still very hot right now as well as multi-family. When it comes to office space, lenders are certainly going to be more hesitant unless you have good pre-leasing and good leasing already in place. Until we figure out what the world’s going to look like post-COVID, that’s one sector that has slowed down some. And then hospitality is still slow, but I think it’s starting to come back a little bit.
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Our brokers and other partnering commercial real estate experts will be answering your questions every month through the Ask a Broker series. If you have a commercial real estate question that you want answered, we’d love to hear from you at email@example.com.