In this article, we’ll provide theÂ know-how you’ll need to secure the trust of aÂ borrower in a commercial real estate loan transaction–trust that is contingent on your capacity to manage multipleÂ lenders.
Did you know thatÂ underwriting and marketing a lender package is one of the full service options we offer right here at REsheets? Whether you want to learn the process yourself, or better understand ours, this is your step by step resource to building aÂ professional lender package.
Before we start, let us differentiate between the type of analysis necessary for securing a loanÂ andÂ the analysis we use in valuing a property for purchase or sale. You’ll notice on our product page that we sell 10-year discounted cash flow models. Let’s take a look inside the DCF through the lens of aÂ lender.
Although the DCFÂ covers the impactÂ of financingÂ on the property, it doesÂ not account for the precisionÂ required in securing a loan. In aÂ commercial or apartment DCF valuation model, financing is a fact, not a process, in other words, it acceptsÂ all the information necessary to calculate interest and principal, runs theÂ financing on theÂ bottom line cash flow, but cannot accurately account for the feasibility of securing decent financing, nor can it fullyÂ identifyÂ the factors necessary to secure the best possible financing. Don’t get us wrong, the DCF is highly valuable to investors for buying and selling, but less valuableÂ to lenders.
Financing section on a sample cash flow model’s executive summary.
So what makes a lender package?
A straight to the point request attached to crucial and appropriate financialÂ information. We can divideÂ the package into 6 main parts, so let’s get to it.
- TheÂ RequestÂ | This is what we’re asking for, so let’s be upfront with it. It’s as simple as the $ amount of the loan we’re requesting, and the percentÂ of that $ amount to the value of the property as a whole (%LTV). The lender wants to know what’s at stake, and how much skin they’ll have in the game–they’ll expectÂ the fine print to follow. The request shouldÂ be the package cover, complete with a flattering photo of the property.
- The Property Basics | Ok, the lender knows what’s required from them, so now they’ll needÂ to get their bearings.Â The property basics are anything but flashy. We stick to the specifics in a clear, concise layout: name, address, property type (retail, multifamily, industrial, office, hotel, mixed…), year built, renovated, rentable SF, lot size, etc. Too much moreÂ isÂ overdoing it.
- The Historicals | An investorÂ may not care much for a property’s past performance, she’sÂ confident in herÂ capacity as a commercial real estate wizard, and knows exactly what a property will produce once sheÂ lays herÂ hands on it. A lender, on the other hand, won’t budge from history. A lenderÂ requires at least 3 years of historicals to be exact. Although future performance is a factor for a lender, the past can never be forgotten. It’s important to lay out clear historical columns a lender can analyze at a glance: actual income, actual expenses, capital costs, and all the jazzy ratios that come with financial data–expense ratios, operating margins, and DSCR and Debt Yield ratios. It’s important to base loan ratios on the debt service of the requested loan (not a loan currently encumbering a property) as a lender will want to see how a property holds up under the financial burden of the loan in request. A lender willÂ need a Net Cash Flow Debt Service Coverage Ratio (NCF DSCR) greater than one–a property can’t have less cash on hand than the price of debt. Also,Â a Debt Yield (the net cash flow divided by loan amount) of at least 10% to keep the lender comfortable. If the property’s historyÂ isn’t helping the story you’re telling a lender, don’t panic, there’s still hope.
- The Underwriting | Here’s how we separate the casual conversationalist from a commercial real estate analyst. Lending is all about mitigating risk, and weÂ can useÂ the practices of these mitigationsÂ to benefit theÂ property. For example, if your property is currently running at 100% occupancy, the bank will assume a rate of vacancy equivalent to comparable market conditions. IfÂ comparable retail centers in an exampleÂ market hover around 90% occupancy, we will need to show the lender how our property handles those conditions byÂ a 10% vacancy assumption. However, if our property has below market $/SF rent, we can increase our Gross Potential Rent by theÂ difference in market rent andÂ account for it as vacancy, thereby removing some or all of the extra vacancy assumption that must be included by the lender. In this example, if we hadn’tÂ proactively accounted for the vacancy we knew was coming, the lender may have taken it right off the top. Management and capital costs are other examples of lender requirements which may be accounted for in similar fashions. The best underwriting typically involvesÂ a T12 withÂ rent based on current rent roll/unit mix, but depending on the property, the underwriting may need to be adjusted in order to tell the most accurate story.
- The Rent Roll/Unit MixÂ | The historicals and underwriting showÂ the bottom line, but a lender wants to see the workings, in other words, the individual contributors to property income and the risk associated withÂ each tenant. In a retail example, the package shouldÂ showcase in a concise layout: theÂ tenants, SF per tenant, % gross leasable area, lease start and end dates (remaining months is a bonus!), any lease extensions or options, rent & CAM (annual and /SF), and even market rents per tenant space. We should see summaries of each column, GPR, occupied rent/SF, and even a rollover graph of current tenants.
- Note: A lender may only take into account tenants with up-to-date lease contracts, especially an anchor tenant, and if a renewed lease is notÂ agreed on at the time of consideration for a loan, the lender may not be willing to include the tenant as part of the underwriting. Sometimes it’s up to the underwriterÂ to convince a borrower of the necessity of signing or renewing a tenant to make a loan feasible.
- If the property does contain a significant anchor tenant, the bank will likely wish to see tenant sales and occupancy cost ratios.
- The Marketing | Finally, it’s called a lender package for a reason. We’re selling a property’s income production potential and risk to a bank. While we never falsify any portion of the package (which could cause major complications down the line), it is our job to give a property its best opportunity at securing greatÂ terms. This includes providing information on the owner and his or her history, providing marketing photos and material, and ensuring that a lender feels comfortable that your underwriting is sound, thorough, aggressive, andÂ honest. A lender will often quote loan terms based on a lender package alone if that lender package meets the accepted criteria. Don’t be afraid to ask for great terms, this isn’t justÂ requesting a loan, butÂ anÂ opportunity to show the lender that he or she needs to be competitive in order to win your financing.
We willÂ discussÂ some ofÂ the tactics involved in managing multiple lenders in an upcoming blog.
This blog is for educational purposes only.