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National Mortgage Professional
Apr 22, 2007

Big opportunities from small-balance commercial mortgagesScott Riellymulti-family, mixed-use, fees, residential mortgage market The small-balance commercial mortgage market is anything but small. Loans on multi-family, mixed-use and other commercial property valued at $5 million or below make up a market of some $130 billion per year. This is despite the fact that more than 20 percent of commercial property sales at these values include no debt, according to research published by the Mortgage Bankers Association of America. What's more, five percent of the financed transactions involve private party or seller financing instead of a traditional institutional lender. And while refinancing might be stagnating in the residential market, it is growing in the small-balance commercial market. If you need more reasons to pursue this market, try these: 1. Fees on small-balance commercial mortgages can be significantly higher than those on residential loans. The highly competitive and transparent residential mortgage market has compressed origination fees for both purchases and refinancings. Small-balance commercial mortgage fees, on the other hand, are typically one to three points. Moreover, average loan amounts for small-balance commercial mortgages are generally higher than loan amounts for residential mortgages. 2. You should have no trouble finding borrowers. You can start by talking to your existing residential borrowers. Many buyers of small commercial properties are affluent investors seeking to diversify their investment portfolios. First-time buyers often go to bankers, brokers or financial advisors with whom they already have relationships. With typically strong credit scores, these investors are excellent prospects. Refinancing offers additional opportunities. Many small-balance commercial properties are owned outright or have existing financing with onerous rates and terms, including balloon payments. Yet many residential lenders and brokers shy away from the small-balance commercial market. One reason is that the origination process is more complicated and more expensive than that which is associated with residential lending. Residential underwriting often requires little more than a borrower's credit report and an appraisal based on comparables. But to underwrite a small-balance commercial mortgage properly, the lender must evaluate the property and the borrower's credit. Property analysis includes inspections, environmental assessments, rent rolls, lease reviews, renovation costs, occupancy rates and other market data. Unfortunately, this is true for all such loans, no matter how small. Many residential originators simply lack the expertise or resources to conduct this analysis. Another reason for hesitation is the relatively long time period to close commercial loans - 90 days or more in most cases. This creates more fallout risk than residential loans' shorter time frames. Even if a lender has the resources and proficiency to underwrite small-balance commercial mortgages, the secondary market is much less developed than for residential loans. It's harder for lenders to sell small-balance commercial mortgages - a potential problem if they're not originating loans for portfolio. A well-funded partner with access to the capital markets can mitigate all these potential issues. Such a partner offers underwriting flexibility because it can diversify risk among the many loans it purchases and securitizes. The partner may also enjoy certain economies of scale, such as access to a blanket environmental insurance policy. As a result, the partner can help lenders and brokers originate a broader range of small-balance commercial mortgages. You should seek an experienced partner that has an appetite for loans and an efficient turnkey process that minimizes costs and speeds time to closing. Because the process itself is generally the most significant impediment, look for a partner who offers a proven one - from pre-qualification to application to third-party services and through to closing. This enables you to offer more competitive rates, better service and higher likelihood of closing. A good partner can transform your small-balance commercial mortgage activity from a sideline to a core business with long-term benefits. Lenders who originate these loans will see more than revenue growth. Since the loans can be sold rather than retained in portfolio, lenders will also see growth in return on assets and return on equity, two key measures of lenders' efficiency and overall performance (and often key determinants of senior management compensation). For public financial institutions, return on assets and return on equity are important signs of healthy financial performance. Here are key qualities to seek in a partner: -Does the partner offer both fixed and floating rates - a broad enough mix to meet borrowers' wide-ranging needs? Do the partner's rates and yield-spread premiums ensure your profitability? -Does the partner have clear and easily implemented underwriting guidelines? You cannot afford to evaluate every small-balance commercial mortgage application in isolation and then wonder whether you'll find a buyer. The partner should provide standard guidelines that make the loan-approval decision almost automatic. -Can the partner supply a comprehensive package of third-party services, such as appraisals, inspections, legal documentation and environmental insurance? -Does the partner have an efficient Web-based process that ensures quick closings (as fast as 30 days) and lowers fixed labor costs so you can offer more competitive rates? -Does the partnership position you well for the future when the small-balance commercial mortgage becomes more of a commodity, like residential mortgages? -Does the partner compete with you? Or do they work exclusively with originators and not directly with borrowers? The last thing you want is a funding partner who is also your competitor. -Can the partner provide additional value-added services, such as marketing support and lead generation? -How sophisticated is the partner? The small-balance commercial mortgage business is fragmented primarily because there's no efficient secondary market for these loans. You want a partner who knows and understands the capital markets and has a successful track record of securitizing small-balance commercial mortgages. Lastly, is the purchaser of your loans also a principal in the securitization? An institution that purchases loans merely to resell them is quite different from a long-term partner who retains ownership of non-rated and non-investment-grade bonds from securitizations. A true partner with skin in the game will likely have a better appreciation of the risk and will be not only capable of but also empowered to make underwriting decisions based on a thoughtful analysis of all relative factors. With this type of partner, you'll have a steady supply of table funding, your rates will be competitive, your loans will close and you'll build a strong reputation among your borrowers. Scott Rielly is executive vice president of Stamford, Conn.-based CBA Commercial LLC. He may be reached at [email protected]
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