Now is a good time for competent residential brokers and loan oficers to expand their market to include at least some commercial lending. This would make up for the declining residential business, and at the same time, would make the loan officer more valuable to their present or any future employer, not to mention the added benefit to a client that may just have both commercial as well as residential needs! However, this must be done carefully, selectively, and
professionally. Many good residential loan originators still shy away from commercial loans, assuming that these are too complex, take too much time and “never” close anyway. In reality, much of the commercial lending, conceptually at least, can resemble full doc residential deals (especially when this may involve self-employed borrowers). Some of the terminology will be different, and certain ratios or contingencies employed will be different. However, these are not impossible to learn, and those that do learn, remark later that had they only known what it really took to be proficient in at least some of the commercial programs, they would have started much sooner, and made much more money! They would then be in position to enjoy the full benefit of cross-selling between residential and commercial lending!
There are basically two myths that one needs to overcome!
A) The first is that commercial lending is TOO DIFFICULT.
B) The second, is that one can earn LOTS OF MONEY WITH VERY LITTLE WORK.
The first is simply wrong, while the second is childish and is perhaps, a product of the “instant gratification” culture that somehow infested our society, AND recently, the mortgage origination business.
Yes, commercial lending does involve different concepts, has its own specific rules, but learning these is no more difficult than learning new residential program. For those who were not afraid to invest a bit of time learning the many aspects of FHA (203b and 203k, etc.) or more recently, the rules and procedures regulating loan modification, learning the basics of commercial lending can be even deemed easy! Very little politics, and mostly arithmetic and common sense here! Underlying logic will consistently be: “Would you lend your own money to: this borrower, for this building, for this purpose and, will this property be able to carry the debt service?”
What can one legally earn doing commercial loans?
In a market-driven economy, regardless of how bad it may be, the answer is always: “whatever the market will bear!" However, this still implies: being competitive (don’t lose your clients mid stream), establishing a reputation for delivering on one’s promises (grow a referral base), and knowing what you are talking about (maintain credibility)! Being mindful of all of the above will convey confidence to your client, who is often at least somewhat better prepared than an average, perhaps naive, residential client. There is little room for childish exuberance
nor blatant greed and BS! Commercial lending is an adult business for mature players! There is no shame in not having all the answers to all the questions all of the time. Honesty always wins, eventually! But there is shame for peddling nonsense or not getting back to your clients with clarifications, even some of the time!
Minimum basics to get you started
So, what does one really need to know and be prepared to do in order to embark on the commercial trail, properly equipped? Aside from maturity and good business ethics referred to above, one must not be afraid to ask questions! Perhaps, lots of questions! And, you may need to explain--to the borrower, why you ask specific questions! You need to get to the bottom of all of the possible issues involved in a case. You must understand the needs of the client completely and recognize possible property issues before you can make a sensible recommendation and then execute it. This will then win for you the trust and referrals from this client!
Like in residential lending, credit of the borrower(s) is very important as is the borrower’s ability to accumulate (and retain) a savings (liquid assets)! While personal income is rarely used in qualifying a deal, one still almost always will need to show income! Again like in residential, we need to know if this is a purchase or Refi (CO or R/T) and if a refi, when and how was the property acquired (seasoning). If this is a cash out, seasoning is especially important, as is what the CO will be used for. So far, if you think this resembles residential lending, you are correct!
From this point on, things may begin to look a little different. However, the common sense/logic is still the same! Is the subject property owner-occupied or strictly investor/rental? Remember that
in commercial lending, the property must carry itself. Therefore, in a purely rental/investor scenario, there is much less emphasis on personal income and much more on the leases and how much of the property expenses are paid by the tenants (in addition to their
base rent). If the property is owner-occupied, then the personal income, or the owner’s business income (if the owner occupancy involves a business, such as a restaurant, store, medical office, etc.) becomes critical. Therefore, tax returns of the owner-occupying business is a MUST, as much as the leases for all other tenants. The personal tax returns of the owner in one case will be looked at strictly to establish the fact that there is little risk of a tax lien. In the other case, is the OO, especially the business, really able to pay the market rent (as established by the appraiser).
In residential lending, you know that there is an LTV as well as income ratios that must be satisfied. Why should commercial be different? Underwriting will want to know that income from
leases, less the expenses, is sufficient to carry the loan. But what defines “sufficiency." We call it Debt Service Cover (DSC). In plain everyday language this is simply: How much
excess (extra) net income must the property have in order to make the mortgage (P+I) payment Nothing more, nothing less! Therefore, if the desired loan will need $100,000 per year to cover the P+I, a DSC of 1.25 says that the property MUST generate at least $125,000 of NOI. DSC minimums differ depending on property types, occupancies, borrower credit profiles, etc. A DSC of 1.25 is a typical starting point for most properties. A good apartment property can require as little as 1.20 or even 1.15 DSC, while a light industrial or warehouse case may need to see 1.3 DSC or higher.
Another area of significant difference from residential lending, is HOW commercial property values are established! Recall that it is the property income, the ability of the property to carry the debt that is the key to getting the loan. Unlike residential that uses sales comparisons, commercial
appraisals focus on rental comparisons! Therefore, it is the comparable income generating capacity that will dictate value. Since this is a much more tedious effort, commercial appraisals are much more expensive than residential where the comps can be often found via public data Web sites! The NOI of the subject property and the comps, divided by the
area’s typical return on investment (Capitalization rates--a.k.a. cap rates) defines value. Sometimes, these values match values determined by sales comps, but most often they
do not, especially now. You may always obtain a reasonable estimate of an area’s current cap rate from a good appraiser if you want to confirm an optimistic value given to you by a
borrower. Take this cap rate and divide it into the about 90 percent of the NOI figure given to you by the client (The 90 percent will approximately cover the underwriter’s unavoidable
contingencies for vacancy and management fees.)
OK, so where to now?
There are many different commercial property types, some are much easier to work on than others. For those who are relatively new to commercial go after the multi-tenanted properties
(risk is distributed), which include apartments, mixed-use, retail strip centers, offices, etc. Here your basic portfolio of information [other than items you are already familiar with
from your residential experience such as credit reports, tax returns, personal financial statements and bank statements (ie: assets)] will be: All the property leases, a list by name of
all tenants with start/end dates for their leases, and the property expenses (taxes, insurance, utilities, routine maintenance, legal, accounting, size of any commercial space in terms of square feet, etc). Owner-occupied properties will, of course, require a little more info, specifically the owner’s personal and the occupying business’ income.
There are many other type of properties including, but not limited to, the single tenant big box loans, construction/development projects, automotive (ranging from dealerships to gas stations),
industrial, any single tenant or owner-occupied property where the tenant cannot or will not show their tax returns. These MAY BE BEST TO AVOID, at least at this time .... or until you are very familiar with all the underwriting nuances that may be present in these cases. For now, simply refer these cases to your favorite competitors! (However, let them buy their own Excedrin!)
At the very least, speak to your commercial lender, and discuss these deals in detail, before making any commitments to the borrowers!
As far as selecting which commercial lender to work with, again you have fewer and fewer choices. Ideally, you want to work with a “generalist” as opposed to a niche lender who concentrates only on a limited number of program types. Niche lenders usually do not work the secondary market, and if the property or a case does not exactly fit their target profile, you are out of luck. This is especially so, due to very little document portability in the commercial arena. So, not only did you burn up valuable time and your client’s trust, you may well have unnecessarily burned up your borrower’s available funds for appraisal and environmental work, which may now have to be done all over! A mortgage banker who works the full range of available programs nationally, may be your best bet.
Also, have a good broker fee agreement in hand as soon as you determine the client’s needs and establish their trust. However, Do NOT be greedy!! Your fees should be in proportion to work
performed! Do not rely on yield spread premiums (YSPs)! YSPs, as we knew them in the past, are disappearing. One wholesale source that offered very attractive YSPs in the past, was just recently caught circumventing the banker/broker by going directly to the borrower. The borrower
was honest and smart enough not to go for the bait! Circumventing the broker saves the short-sighted commercial lender (or the individual loan officer) the significant costs associated with YSPs!
So, to recap briefly all of the above:
► Commercial lending can provide a great opportunity to enhance your current production, provided you are willing to learn a few new concepts, new terms, and procedures. For a GOOD residential loan officer, this will be as easy as learning “another FHA” program!
► While there is an over abundance of residential loan officers, there is a shortage of good commercial loan officers. Because you may have done stated or no doc commercial loans in the past, do not become overconfident in today’s market! The market has changed!
► However, it is not that difficult to become at least a little conversant with the basic commercial concepts! Forget, the so-called stated income, or SISA loans. Their time is past, for at least the foreseeable future! Those portfolio lenders that did offer these, are now sitting on major, non-performing portfolios. And some are getting TARP funds! The extra price they collected for “stated” processing, is of no help to them now! Much of the time, personal income would have been collected, but not used anyway!
► Focus on the fully rented, multi-tenanted properties, collect the leases (in New York City, get the DHCRs) and the actual expenses. Remember that most of the time it is the property income (less the expenses and underwriting contingencies), ie: the NOI, that will establish the loan amount. Remember also that you always need a little “overkill” (DSC) with the NOI--typically about 20-25 percent.
► Finally, don’t be afraid to ask questions, for ask you must! It is far better to do so as early in the process as possible to avoid embarrassment!
Serafim Ivask has been actively involved in the residential and commercial mortgage industry for 24 years. Currently, he is vice president of CM Funding Corporation, a commercial mortgage lender accepting loans nationally. He may be contacted for further information at