Understanding commercial mortgagesBrian L. Peartcommercial mortgages, diversifying income
Welcome to the world of commercial mortgages. With the following
article, I hope to offer some insight to the residential loan
officer who is venturing out into the world of commercial
mortgages. I also intend to introduce you to some of the
differences between residential and commercial loans, and hopefully
help you to be more profitable in your quest for diversifying your
income through commercial loans. I will endeavor to teach you the
who, what, when, where, why and how of commercial mortgage loans.
Knowledge is power, and my goal is to give you that knowledge -
accurate knowledge. And so, let's begin ...
Who?
Who lends the money in the commercial realm? This is the first and
possibly most important difference. As residential brokers, you
sell your loans to a large lender or bank or some financial
institution whenever you do a loan but the money is not really lent
by that institution. Ultimately, they sell the loan to Fannie Mae
or Freddie Mac and are reimbursed. They keep the servicing rights,
and Fannie or Freddie then bundle all of those loans and pass them
through to investors as mortgage-backed securities.
In other words, the bank is not really lending their own money.
In the commercial realm, most loans are done by banks, with their
own money. They take the money on deposit and loan it out to
different companies. There is no giant waiting to reimburse them.
If that loan defaults, the bank is stuck (unless they can sell the
property for a profit). Because of this, they are more selective
than they would be on residential loans.
But that's not all. Eighty percent of all businesses fail within
two years, and if someone does fall into financial difficulty, they
will let their commercial investment falter, rather than leave
their wife and kids without a house to live in. Commercial loans
are investments, and we all know the rules are stricter. Because
each piece of property is completely different, commercial deals
are not hard and fast; there are no 28/36 ratios here.
Simply put, the property is more important than the borrower. If
you find an excellent borrower with a bad property, no one will buy
the loan. The good news is that if the deal is good, there is more
than enough commercial money available. Banks want to lend, they're
just more careful when it's their own money. There is a bundling of
commercial mortgage-backed securities, but that market is nothing
compared to the residential side, and even then, the property and
deal is still specifically looked at.
What?
What takes commercial deals longer than residential loans to close?
Rare is the commercial loan that closes in less than a month, and
the rate for those types of deals are more like hard money. Small
commercial loans will usually take two months and larger ones can
take as much as four to six months! Many factors go into closing a
commercial deal let's start with the appraisal. It will rarely be
ordered before the loan is approved and the borrower has committed,
which could be several weeks into the deal. Once ordered, an
appraisal on a commercial property will often take a month or more,
depending on the size and usage of the property. Ultimately, the
property's value will be determined by its cash flow. The appraiser
of a commercial property has to get the financials on the property
and compare it to similar properties in the area. If my apartment
complex is 70 percent rented and the average complex in the area is
75 percent rented, it will affect my appraisal. How the property
has been managed is important. How quickly the appraiser can get
that information is important. The appraiser must often contact an
owner and get information directly from them, and it is rarely as
easy as pulling up an MLS listing.
The broker often can drag the file because they do not get the
information needed up-front. If my apartment complex is running 30
percent vacancy compared to most places running 25-percent, I need
to explain that reason. Most brokers will send a deal with a
residential loan application filled in, a credit report and
two-years worth of tax returns and think the loan will be approved.
When asked for the stuff that is really needed three years of
operating statements, business plans for the property, etc. they
balk at getting it. The loan will never get approved just based on
tax returns and a credit report. Why? Because the property is the
most important factor. If you get the right documents in a timely
fashion, your loan will move through much quicker and have the best
chance of getting approved. And of course, a loan could drag
because of a borrower dragging on getting needed information ...
but we're used to that, aren't we?
When?
When do I get paid? Most commercial loan fees are due and payable
at time of commitment. In other words, the customer signs into a
certain rate and structure, and you get a commitment from a bank or
entity for it. However, it is usually not collected until the
closing. Herein lies another danger with commercial loans. With
residential loans, the package comes from the lender, your fees are
there, and everything is fine. On the commercial side, the customer
has much more clout. Often, it is no problem, but sometimes, they
can cut you out of the deal.
The customer is also looking out for themselves, and they will
beat you up on fees and threaten not to close. They may tell the
bank they do not want to pay the brokers fees on the closing
statement; they may try to find out who you are using and go
directly to them anything to avoid paying an extra broker's fee. It
may sound like I am being overly negative, but I am not. You should
either deal with your existing customers, or work with a company
who has already established some relationships (and acquire some
legal expertise to protect your fees).
Where?
Where can you get commercial deals? They are everywhere! All you
need to do is mention that you do commercial deals and people will
immediately begin talking. It is a great hook for approaching real
estate agents. Just drive through any area and look at the
properties. With rates this low, most properties can be refinanced!
The commercial mortgage market is huge, and there is considerably
less competition than in the residential market. It's great
residual income!
Why?
Why do commercial loans? If they are so deal-specific, take longer
to close, and include more difficult customers who are trying to
get out of paying you, why bother? It's simple. Commercial loans,
done right, can be profitable. They give you an edge over other
brokers, and it's smart to diversify your sources of income. Most
importantly, it gives you a natural hedge against rising rates!
What do I mean? Commercial activity increases as business and the
economy improves, and consequently, stocks do better and our rates
go up, slowing down refinance business. As that happens, the
commercial marketplace heats up.
How?
How do you get started? Two ways one quick, the other longer, but
both have merits. The longer way is to take all the classes and
instruction you can find on commercial loans and try to place them
yourself. Although you will keep more of your money that way, it
will take years for you to get really good at commercial loans.
The quick way is to pick a company that you will work with. They
should have contacts in several states, but also access to Wall
Street money and nationwide commercial lenders. They should have
experience doing commercial loans and not be tied to one lending
source. To start, refer the deals to them, and let them do the work
while you watch and learn. You will pick up the rules as you go
along and end up becoming more knowledgeable in a shorter
time-frame. You will initially make less, but you will close more
loans, have less headaches, and ultimately, be able to branch out
on your own.
Commercial loans are picking up right now, which means that low
rates are close to being over. Begin now to diversify your income
and tap into this growing market!
Brian L. Peart is president of Nexus Financial Group
Inc., and its commercial division, Commercial Capital Ltd. He
is a national trainer and editor of Top Producer magazine. He may
be reached at (866) 355-1244 or e-mail
[email protected].
