Every month we feature a CRE Expert who answers some questions about topics related to commercial real estate. This month Jim McNulty, senior vice president — business banking of Oak Bank in Fitchburg, Wis., gives us some insight on the ins and outs of financing CRE loans.
Given today’s lending environment, what is the baseline framework needed to structure a serviceable CRE loan transaction? Are there segments or characteristics that make a deal easier or harder to finance?
The Commercial Real Estate Loan. It’s frequently the bread and butter for many of your local commercial banks. Despite what you may have heard over the years since the economic downturn, most banks want to loan money. And we want to make it as easy as possible for everyone involved. Market changes and regulatory pressures have certainly put some hurdles in the process, but really it’s not that complicated if you think like a banker.
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Bankers want what they have always wanted – to loan money and get paid back according to the loan terms. Really. That’s it. In a nutshell, we are simple creatures. As with every question that looks easy, however, once you start to dissect things, some complexity creeps in and dictates the necessary framework for a happy deal.
CASH FLOW: A deal is still ruled at its core by cash flow, cash flow, cash flow. Most of the analysis comes down to answering this question: Can we show that the property will produce enough cash flow over the life of the loan to make the payments? It’s a question that the potential property owner should probably be asking as well. Will there be enough income from the leases? Are we confident the tenants will be able to pay? Are the leases long enough to cover the loan term? If not, what’s the plan? Are we confident we know what the expenses are and that we will have enough cash flow left over after expenses to make the payments? How can the expenses possibly change to throw us a curve ball (repairs, taxes, insurance, utilities, etc.)? All obvious questions, but it is the majority of the analysis. A good lender will ask questions until they are fairly sure that things should work out. Give me free cash flow of 1.25 times your loan payments or more and we’re in business.
Bank Regulator Note – Regulators are looking HARD at our files to make sure we gathered everything to prove cash flow. If we’re asking you for more information, it’s often because we are getting asked to gather more information.
COLLATERAL: It isn’t fun to talk about, but sometimes people don’t make their payments according to the plan. A bank doesn’t want to take collateral, but if the loan isn’t getting paid and things can’t get worked out over time, then selling the property to pay off the loan is the eventual end game. After 2008, we saw how property values can decrease and how tenants can fail to pay their rent. Because of that, banks and regulators shifted towards what many of you have seen – the need for stronger loan-to-values in the collateral backing the loan. 80% or higher loan-to-value deals are still a possibility, but they are certainly rarer than they used to be. More of a cushion is needed to protect in a situation where things don’t work out. Give me 75% loan-to-value and we’re in business.
Bank Regulator Note – This is probably obvious if you’re in the business, but appraisal rules and regulations have become a VERY HOT ISSUE with the examiners. A very thorough and structured appraisal process part of the world we live in.
THINK GLOBAL: You may have heard ‘Global Cash Flow’ when discussing a deal with a bank. A specific property or project may work on its own, but if the owner of a property has financial stress in other parts of their lives, it can impact their ability to get a transaction done. Global analysis is why we are often asking for tax returns on borrowers and related entities, rent rolls for related properties, personal financial statements showing all related assets, liabilities and obligations, etc. We toss it all together and try to ensure that stress somewhere else won’t potentially harm repayment on our specific deal. And yes, the Regulators are looking at our files for this as well.
If your deal has a solid cash flow plan, adequate loan-to-value coverage and globally the borrower is in good shape, you’ve probably got a solid deal. This has always been the case, but in today’s environment you have to be ready to deal with a more complicated process while proving things out. It adds cost and time, but it’s the reality of today’s lending environment.
A good banker should be sketching the entire process out when things begin, explaining the issues and providing creative solutions to help get a deal done. It certainly feels at times like banks are creating hurdles to keep a deal from happening, but in reality they are trying to answer the questions above, getting comfortable that things will work during the life of the loan.