Lenders Moving Up the Leverage Curve

By Todd McNeill

In the current commercial real estate capital markets environment, the best sources for reasonably priced property acquisition financing are the Banks and Conduits.  However, the underwriting approach, and ultimately how a Bank gets to a loan quote versus a conduit, can vary dramatically.

Banks Focus on The Borrower First 

commercial real estate lendingTypically, banks will commence underwriting of a deal beginning with the Borrower, Sponsorship, and the credit strength of the proposed guarantors of the loan request.  Banks will want to see “global” debt service coverage of the guarantor’s contingent liabilities and cash flow of their entire portfolio of properties.  Net worth and liquidity will be scrutinized, and in many cases verification of liquidity will be requested prior to loan approval.  In most all cases, the bank will require at least two years’ prior tax returns for the proposed loan guarantors.  Once the bank fully understands the Borrower’s and Guarantor’s financial strength, they will then focus on the real estate and the actual economics of the property.

Assuming the Borrower/Guarantor credit passes muster with the bank, Borrowers can access attractive financing to enhance acquisitions.  Depending on various underwriting factors, Borrowers with good credit, net worth, liquidity, and global cash flow can expect 75% to 85% loan-to-cost financing (subject to 75% LTV) with the cost of the money (interest rate) ranging from 4.5% to 5.5% interest.  In most cases, Borrowers can get up to 24 months of interest only before an amortization commences (usually on a 20- to 25-year schedule).  Typical bank fees are in the range of .5% to 1%.  Borrowers should also anticipate a completion guaranty at a minimum but most likely will see recourse of “top 25%.”  Loan terms usually last 5 years but in some cases can extend to 7 years.

Conduits Focus on the Property First

Conduits will commence underwriting a property by going right to the real estate fundamentals of the deal.  Since conduits underwrite with a non-recourse structure, the real estate cash flows and the history of the cash flows are critical to determining the loan amount.  The Conduit lender is going to want to see the past three years’ Operating Statements along with the past three years’ occupancy history.  The conduit will detail the future tenant rollover and the cost to re-tenant the property.  Future tenant improvement and leasing commission costs along with future anticipated capital improvements are all determined as part of the loan terms and will be reserved from the property income and held in escrow for the Borrower to use as needed during the loan term.  Occupancy of 85%+ is likely a necessity for the conduits.  Last, net worth, liquidity, and Borrower credentials are scrutinized but in most cases can be mitigated with loan structure.

If the metrics outlined above are satisfactory, the Borrower will typically see a loan with up to 75% of cost with a few loans hitting 80% of acquisition price.  As indicated, these loans will be non-recourse with industry standard carve-outs.  The loan term will be 5, 7, or 10 years fixed at a rate of around 4.75% to 5.5%, with 30-year amortizations being the norm.  For most acquisitions, expect to see at least two years of interest-only before amortization.  The conduit lender does not charge an origination fee; however, expect higher legal fees on these transactions to partially offset the fact that the conduit lender takes no fee.

Conduits will also offer mezzanine financing to go along with the first lien financing.  There have been numerous conduits offering mezzanine loans from as small as $1mm to as high as 90%, with the norm being 85%.  Pricing on this mezzanine financing will be 10% up to 14%.  These mezzanine loans will be underwritten on current cash flow and will not take into account proforma or potential future events.

Depending on the Borrower mentality, there is reasonable acquisition financing available in the marketplace.  As you can see, banks and conduits go about their underwriting differently, but both can offer aggressive terms if you and/or your property qualify.

Recently, MCA arranged a 75% LTC acquisition loan for a 60% leased grocery-anchored shopping center that was priced at 4.5% fixed interest for a 5-year term, 25-year amortization with the Borrower only signing 25% recourse while having the first 24 months of the loan term being interest only.  These terms came from a bank as noted in the recourse provision.  Nevertheless, these were still very aggressive terms for a value-add retail deal.  Due to the occupancy, this particular deal did not qualify for conduit financing, but had the occupancy been 90% +, the conduit market would have also aggressively quoted this deal.

Regardless of whether you might be pursuing a bank or a conduit loan, Metropolitan Capital Advisors has the experience, expertise, and deep-rooted capital relationships to provide you with the best advice and alternatives.  To discuss your upcoming finance requirements, contact any one of our Senior Directors at www.metcapital.com.

Posted on by Scott Lynn in Commercial Real Estate Finance Comments Off on Lenders Moving Up the Leverage Curve