How does commercial financing work?

Question

I have only looked into residential financing (4 units or less) and am familiar with the requirements. Debt to income ratio is pretty much killing that type of financing for me for a while, even with a big down payment.

How does it work to get financing for a 5+ unit building. What are typical requirements?

Vanessa Brown · Answer

I think one of the things that you will find most interesting about commercial lending is the amount of flexibility and creativity that can occur. This is an area that fascinates me because after about 10 years in residential and only 4-5 in commercial I am still surprised by what is possible. This is especially so if you go into private commercial funding.

Everyone has given you some really good advise. The only thing that I wanted to add is that you need to be prepared for the cost of business. While it's always a good idea to avoid up front fees etc. There is also a cost of business associated with the deal that varies a lot from residential. For just a house there's an appraisal, inspection, and other than credit reports and possible application fees and down payment you're good. With commercial the property is just as important as you are and there are going to be a full work up on the property's gross operating income, operating expenses, neighborhood gain or loss, depreciation, etc.

Be prepared for lots of papers and a longer closing time.

Doug Fath · Answer

Brian...Nathan is correct that even commercial banks are going to look at your DTI, just as a residential bank would.  The advantage you could have if you are purchasing a cashflow rental property is that the commercial lender will typically include a % of that rent roll towards your income which should improve your DTI.  ( I believe some residential lenders include this but not all....not 100% sure because it's been a long time since I've used residential financing)

David Beard · Answer

There's a lot of info on this site:

http://www.commercialbanc.com/apartment-loan-small-overview.html

For these mid-sized types of deals (say loan size 500k to 1mm), they want to see minimum physical occupancy percentages (anywhere from 70-90% minimum), stabilized performance on the property of 6-12 mths with results exceeding minimum DSCR of 1.25-1.30, experience by the borrower, borrower residence proximity to the property of 100 miles or less, possibly professional mgmt, etc.

Small deals up to 12 units, you're probably just dealing with the commercial/portfolio lending group at your local bank, not these national lenders.  Your local bank will probably want to give you a 5-year balloon note.  They seem to all want the flexibility of the balloon these days, they're not committed beyond the 5 years.  Your small local bank will look at all the same stuff, possibly be a little more accommodating, especially with a strong personal guaranty.

Bryan Hancock · Answer

That is a pretty broad question Brian.  It really depends on what you are looking to finance.  MFD, retail, office, etc. all have different requirements.  Darryl Dahlen and Kevin Yeats on BP are experts in CRE financing.  I would suggest you give those guys a call and pick their brain on your specific target property type.

DSCR is big in CRE financing.  1.25+ DSCR seems to be common today.  Other big differences are:

-Hard to get long-term, fixed-rate money
-Hard to find non-recourse financing to justify purchases of small CRE buildings
-Lock-outs, prepays, etc. are common
-CLTV parlance common
-Floater money has various spreads to arrive at the fully-indexed rate

Hope that helps some.  Some of the experts can jump in and lecture me about what I missed or is wrong.  CRE financing is much different than resi financing though.

Darryl Dahlen · Answer

Smaller CRE deals are almost always full-recourse, and as such, you are on the hook for the loan. As others have explained, your credit/income/assets matter to the bank since they want to know you can cover the expenses in the event something goes badly.

That, and they also want to know that you're not living hand to mouth and could jeopardize the property with your "mistakes".

Everyone has gotten the DSCR spot on. Other than that, here is a general list of what banks look at when evaluating a multifamily property:

-historical occupancy (typically a 3 month look-back)
-LTV (70-75%)
-deferred maintenance issues
-management company
-class of the property(A,B, C, or D)
-unit mix
-location
-financials (profit and loss and tax returns)
-number of parking spots (this is a small issue, but can sometimes be an issue on smaller properties)

As David stated, aside from a few national banks who have small balance CRE programs you are often relegated to working with a small to mid-sized bank or credit union on loans of this size. This isn't necessarily a bad thing either.

Bill Gulley · Answer

Generally you're looking  at 75% on gross rents with at least 1.25 debt coverage, that will go up for weaker deals. DTI is a factor as having the capacity to cover the debt for 6 months may be considered by the lender.

A small project 2-12 units just makes it into the commercial loan category and basically the same underwriting issues will be used as in SFD NOO deals with a longer look at:

Management, borrowers experience and track record. If it is in a business entity, what is the structure, who are the principals, their business knowledge and reputation.

Collateral, a closer look will be taken at the appraisal and the lender may visit or at least do a drive-by. Condition of the property! Repairs?

Credit, it's not so much the score as the history, what circumstances may play on any late payment on anything. Credit history gives the picture of who you are, do you manage your finances well.

Capacity, again, the ability to cover the debt. While an initial debt coverage ration is a quick test, it's a judgment call as to meeting the obligation in the event something happens.

Commercial loans can also make other requirements such as  additional collateral, assignment of rents and life insurance on the borrower!

Nathan Emmert · Answer

Brian, in that range you'll be looking at a local bank doing portfolio commercial lending most likely.

I'm not sure it will achieve your goal of fully getting away from DTI issues if you have them... you'll have to see.

James H. · Answer

Bryan Hancock, David Beard,

Thanks for the inpute. I know the question was a little open ended, but I am so unfamiliar, I wasn't sure how to narrow it down. I suppose, more specifically, I am thinking about something with 8 to 10 units, but didn't want to limit the input too much as it is nice to have knowledge at least for comparison's sake.

How does commercial financing work?

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