Many of us have seen the very low mortgage interest rates that have permeated advertising over the last year as rates have dropped down to historic lows. Almost all of this lending “noise” centers around residential lending because of course that is the biggest part of the lending market and affects the 130 million homeowners in the US. Though rates ticked up in March-May rates around 3% are available on 30 year mortgages and if you go to 15 year options I have seen rates starting to bump up against 2%…again historic lows. Inflation however is bubbling and the Fed is sending signals about rate increases not now but into the future.
The commercial lending market for both investment and owner user properties (industrial, apartments, office buildings, retail et al) generally follows or mirrors the residential mortgage maret but rates tend to be a bit higher as they considered riskier and demand more return on the secondary markets and other factors. Commercial lending is more complex than residential due to all the different product types (apartments; warehouses; office buildings, retail et al) all with different demand and supply factors. Commercial lenders sensibly look at the collateral value and condition of the real estate and financial capabilities of the buyer, property condition, tenant strength type/mix (Covid resiliency), and then net operating income and more. But there are lots of nuances. Generally commercial loan amortizations tend to be shorter (20-25 years versus 30 for residential though apartments can achieve 30 years): loan amounts in relation to the appraised value are less and usually in the 70% loan to value range: and rates 1%-3% higher depending on product type, quality, investment/user owner, location and more. Because commercial properties are not so homogenous and there are such a broad range of types , they also take longer to underwrite and sometimes double that of residential loans where a residential loan can be accomplished in 30 days or less, commercial loans can be often be double those timeframes. Even with these differences and sometimes challenges, because of historically low rates, many commercial property owners are investigating the idea of refinancing properties if they are looking at a balloon payment; or want to lock in lower long term rates; pull out tax free cash; estate planning; investment or finally buying or expanding into a new building for their business etc. To navigate the commercial lending market which is more capricious and less linear than residential, it takes some education and research as commercial mortgage lenders all have somewhat differing requirements, preferences and guidelines. One particular case study that I was involved with in helping facilitate a new commercial loan may shed a bit of light into some of this.
Case Study. Owner User looking to Refinance Core Commercial/Industrial Property.
A long term business and property owner of a 15,000 sf older, vintage but well maintained industrial flex building in a good area of Portland (the Central Eastside) was looking to refinance their building which had a loan coming due but also wanted to obtain a better rate and because the loan balance was low, they also wanted to pull out some dollars for other personal uses and augment their “financial cushion” as they were getting older and wanted options. They have a solid smaller business that has been occupying the property for close to 20 years along with a good tenant in a portion (40%) of the building. Their current mortgage holder a bank was not all that competitive, so they I connected them with a commercial mortgage brokerage who has relationships with multiple banks and more importantly insurance and other commercial lenders that tend to be more aggressive for these type of loans. Because of their experience and knowledge, the mortgage broker was able to target those lenders most interested in the type of loan they wanted. After gathering preliminary information on the building; borrowers personal and business financials and the lease for the tenant, they went out to three lending sources to get preliminary loan commitments which basically states the basics regarding rates; fees; loan amounts and often times a couple of options for loan term that usually fall into 5, 7 or 10 year terms where the loan comes due or is refinanced. Because they were looking for a fairly low and less risky loan to value of just over 50% which was around $ 2.5 million of an anticipated value of just shy of $ 5 million, it appealed to several sources mostly insurance companies. Picking a loan term of 10 years on a 25 year amortization at 3.25% they felt was the best option. From there an appraisal was done and inspection and environmental study of the building. It took a bit over 5 months from start to finish but this was partly due to this happening in the middle of Covid craziness. The mortgage broker said that could be now cut down to 60-75 days. Fees here notched in at 2% (1% to lender and 1% to broker) which is high but given other loan details, was acceptable to the owner and these fees can often be rolled into the loan and are deductible.
I got on the phone with several financing sources including a local larger Portland bank; a mortgage broker and a senior loan officer at a large credit union which have been moving into commercial lending over that last decade to get a sense of the current commercial lending market. As mentioned earlier, since commercial real estate has such a wide spectrum of property types, there can be some ranging “views”, but generally here are some observations of the current commercial lending market which all can vary given the aforementioned differences of properties and changing market conditions.
- Rates are up from the beginning of the year and of course somewhat dependent on the type of real estate; strength of borrower and business (if owner user) and there is much more scrutiny of tenants if it is an investment property. I am seeing rates in 3.5- 4% range. Higher rates correspond with longer loan terms: Example: 10 Year loan term 4% and 5 year loan term is 3.5%.
- Loan to Values (LTV) are being pushed down somewhat which were 70% to as high as 80% regularly for many year but that is now being pushed down at or under 70%. Debt service coverage (DSCR) ratios are also bumping up which is basically lenders want close to 20% in historic net operating income above the monthly loan payment or in this case 1:20. Again somewhat dependent on the quality of the real estate product; strength of the borrower and tenant(s).
- All financing sources really like owner-user situations for a business with a good consistent profitable track record. Industrial buildings are still at the top of the favored list along with healthcare i.e. clinics, dentists, doctors etc. Retail is scrutinized much more and need good credit tenants and covid payment history to be proven. The strong part of retail is anything grocery or in the drug/pharmacy bucket which lenders still like and have held up well in Covid. Offices are tough without again good long term credit tenants, low vancancy with tenants that have years on their lease to run. Apartments are their own animal but still seeing lots of available financing and good rates and terms for well performing projects with little Covid rent impacts; historically good occupancy (90%); new (last 30 years) or very well maintained older product Apartments can achieve higher 30 year amortizations especially on newer projects. HUD financing is still a great source at rates under 3% but is a longer and a paperwork intensive underwriting process.
- SBA lending (504 Program) which can be lengthy and have higher fees is becoming a more attractive option beyond their high loan to values (90%) attraction as the SBA during Covid waived many fees and rates are now just under 3% (May 2021) and you can get to 30 year amortizations. SBA is mainly options for owner-user purchases.
- Payoff Penalties have remained pretty much the same usually over the first 5 years of the loan with a declining amount every year such as 5% of the loan balance in year 1. 4% in year two on and on.
A Few Commercial Financing Pointers.
- Have your paperwork in order such as 3-4 years personal income taxes, and for the business as well (if owner/user), and the same for income/expense statements on investment real estate.
- If investment real estate, talk to lenders before making offers or getting properties under contract to understand what loan amounts and terms you can achieve as it will dictate your type and size of transaction and property types which will save time in due diligence and insure you can make a deal happen.
- If Refinancing, know what you want to achieve…better rate; longer term; pull out money etc. Also make sure there is no significant deferred maintenance, good building records, (environmental) meets current codes and building does not need significant capital improvements.
- Talk to your current mortgage holder or business banking firm first as they know you to see if they can compete on new financing. If you are shopping, I like strong local banks as a first option to investigate especially if looking for loans under $10 million. Rates may be slightly higher but finding service if there are issues is much easier and they understand the local market and underwriting can be more streamlined and timely. Credit Unions like OnPoint, Consolidated and Advantis have moved aggressively into these markets and can be a good local sources especially for sub-$1 million loans.
- Mortgage brokers are great resources and options as they have access to larger and varied and often more aggressive lenders such as insurance companies. They know what lenders like regarding type of loans and situations thus often getting better rates and terms and you can get 2-4 loan offers/options to choose from one source. Granted fees may be higher (up to 2%) but can easily be offset by better rates, terms and service.
I have not talked about a bit more “exotic” loans such as bridge/mezzanine; construction; land development; hard money etc which are a small percentage of the market and more complex. I check in frequently with bank commercial loan officers and mortgage brokers so email firstname.lastname@example.org or call 503-705-6380 and I can give you input, advice and connect you.