In today's economic climate, it comes as no surprise to business owners and real estate developers that securing commercial real estate loans can be a huge challenge.
In the past, good credit, a feasible income-producing enterprise and reasonable risk were what it took to secure a loan.
Now, due to the numerous loans that are in default, commercial lending institutions are more critical than ever when reviewing new loan requests.
However, a common misperception is that banks have stopped lending altogether and that it is impossible to obtain new loans. For businesses and commercial real estate developers who have good credit histories and present low-risk ventures, loans are still attainable.
In today's economy, what exactly are financial institutions looking for when considering extending a commercial real estate loan to a business or developer?
First and foremost, most bankers have become wary of transactional lending. Unlike in the past, when businesses could shop around for loans, these days most financial institutions are only interested in lending money to businesses with whom they have existing relationships.
Bankers want to be assured that they are lending to seasoned developers or commercial real estate investors that understand the nature of today's real estate market and have a history of success on prior projects.
Beyond an established and solid relationship with the loan applicant, banks are requiring applicants to answer the following three questions:
- Is the proposed or existing project financially feasible?
- Do the project's primary sponsors have sufficient equity?
- Is there support from guarantors with financial where-with-all?
Financial feasibility
Proving that a project is financially viable is more critical today than it has ever been and because there are a multitude of variables that can negatively affect a construction project, lenders need to determine the long-term financial feasibility of all proposed or existing commercial real estate projects.
Lenders are now asking:
- Are the tenant leases at market rates?
- What types of tenants will lease the space and do they present a potential for high turnover?
- Because capitalization rates play an important part in the underwriting of any commercial real estate loan, will the project sponsor be able to withstand a rise in the CAP rates in the future.
Sufficient equity
The less debt against a project, the more likely it will be able to withstand future downturns in the economy. During the past boom times, some financial institutions allowed as little as 5 percent equity on commercial real estate projects, even on extremely large projects.
Now, most banks require a minimum of 25 percent equity if there is any question about the project's financial feasibility as an income-producing enterprise.
Financial stability of guarantors
The financial wherewithal of a project's guarantors is more important than ever. Once considered a "second-tier" partner, guarantors now must undergo the same scrutiny placed on the primary sponsors of a project.
Lenders are looking for guarantors that have the financial capacity to augment any future financial shortfalls that might occur such as unexpected cost overruns. Because there are no guarantees that a project, when completed, will increase in value, it is important that guarantors come to the table with available cash flow and liquidity.
Although the underwriting standards for commercial real estate loans are rigorous, a proven track record with an existing bank offers the best assurance of obtaining a commercial real estate loan. Transactional loans are fast becoming a thing of the past and are being replaced by relationship banking that, in the long run, will provide businesses a smooth path to future financing.
Charlotte Boxer is president and director of commercial estate markets for Pacific Continental Bank. She can be reached at charlotte.boxer@
therightbank.com.
