"Welcome to the new world" would be an excellent way to introduce and start explaining the world of small-balance commercial real estate lending. Although very much still in its embryonic stages as an industry, there is no doubt that small-balance commercial real estate lending has created a brave new world of commercial real estate finance born from existing voids in the marketplace.
What is small-balance commercial lending?
Small-balance commercial lending can best be defined as commercial real estate loans that fall within the $100,000 to $5 million range, although more specifically, most small-balance commercial lenders will see their average loan size be less than $1 million per loan. Prior to the advent of the small-balance commercial real estate financing industry, the sources for commercial real estate loans under $1 million were very limited, and below $500,000 were even further reduced. Primarily, securing financing for loans under $1 million was limited to either community savings and community commercial banks, or private money lenders. Small-balance commercial lenders have been able to provide a wider range of institutional lending programs when compared to those offered by community banks and institutional alternatives for loans, which typically would have a difficult time finding institutional sources and thus would find the private money lending arena as the only viable funding source.
How is a small-balance commercial institutional lending
program different from a private money loan?
Institutional loans typically provide longer term financing solutions as compared to private money loans which tend to be short term in nature. Private money loans will typically range from one to three years, while small-balance commercial lenders will provide financing for up to 30 years.
Pricing structures also tend to be more borrower-friendly in the small-balance commercial lending arena, with rates starting as low as the prime rate (or even below prime in some cases), whereas private money loans will typically start at prime plus three to five percent. Many small-balance lenders will also offer financing at "par," meaning that there are no origination points/fees being charged, whereas it is not unusual for a private money lender to charge upwards of three to five points.
So everything about small-balance commercial lenders is
better than private money lenders?
Not necessarily. Although the previously discussed issues create very favorable alternatives when utilizing small-balance commercial lenders as a financing source, the funding of the loan will typically take longer than when utilizing a private money lender. Small-balance commercial lenders will usually require a minimum of 30 to 45 days to package and fund a loan, whereas a private money lender can typically fund a loan within 10 business days.
Additionally, if the borrower's needs are for a short-term financing scenario, a private money loan may better suit those needs. Although small-balance commercial lenders do provide a very viable option and alternative source of financing, there still exists many scenarios where a private money loan will better suit the borrower's needs.
How are small-balance commercial lenders an alternative
to community savings and community commercial banks?
Small-balance commercial lenders are able to offer a wider range of loan programs that historically conventional lending sources, such as commercial banks and savings banks, have been unable to offer. One example of this is the advent of stated-income/stated-asset commercial real estate loans. Many small-balance commercial real estate lenders offer stated-income/stated-asset lending programs where, very much due to regulatory confinements and limitations, commercial and savings banks are unable to offer these types of loan programs. The small-balance commercial real estate lending industry also tends to be much more of an objective in nature as opposed to the more subjective nature typical of commercial and savings banks.
Objective versus subjective - what does that
Excellent question! Commercial banks, savings banks and most private money lenders tend to be portfolio lenders. Their lending decisions will very often be based upon a series of subjective "like" questions, such as whether they like the location, like the building, like the borrower or like the requested loan amount, regardless of the numbers associated with the deal such as appraised value, debt-service coverage ratio (DSCR) and credit score. The small-balance commercial lending industry is much more of an objective or matrix-oriented lending industry. In most cases, if the loan fits the matrix as it relates to property type, loan-to-value, DSCR and credit score, then that is a loan a small-balance commercial lender will look to fund and not ask many, if any, "like" questions. In many ways, the small-balance commercial lending industry is mirroring the residential industry in its objective/matrix-oriented mode of lending.
Are there other similarities to the residential lending
Yes there are. In fact, to a large degree, the small-balance commercial lending industry has modeled itself after the residential lending industry in attempting to create a more conforming and efficient industry and also a more residential broker friendly industry.
Some examples of how the small-balance commercial lending arena is similar to the residential lending arena are as follows:
-Loan application: Whereas banks typically require a
commercial loan application, many small-balance commercial lenders
accept the Uniform Residential Loan Application (Form 1003) as a
means of applying for a loan.
-Conditional loan approvals: Many small-balance commercial lenders will issue conditional loan approvals within 48 hours of receipt of a credit report and loan application. The 48 hour turnaround is not typical to the more conventional banking world.
-Rebates: Many small-balance commercial lenders will offer rebate pricing to brokers, which historically has not been offered in the more conventional banking world.
-Buy-downs: Much like the rebate scenario discussed above, many small-balance commercial lenders will allow rate buy-downs, whereas, once again, the more conventional banking world historically has not entertained rate buy-downs.
-Loan processing and packaging: The processing and packaging of loans for many small-balance commercial lenders mirrors the packaging and processing requirements of standard residential loans. In fact, other than the property type and some property-related document requirements, a processor processing a loan for many small-balance commercial lenders will feel like they are processing a residential loan, once again creating a more residential broker friendly environment.
Why so much of a focus on a residential broker friendly
One of the things that has been learned over the course of the early existence of the small-balance commercial lending industry is that residential brokers do indeed see commercial deals - and lots of them! It is a known fact that there are differences in commercial real estate and residential financing, especially when considering how commercial real estate loans are executed in the commercial and savings bank world. We have also learned that these differences have led to very bad experiences for residential brokers when trying to secure financing with commercial and savings banks. So in order to make the industry a more efficient industry, the world of small-balance commercial lenders have set out to create processes that will allow residential brokers to comfortably place loans and secure fundings by mirroring the wholesale business as it is executed in the residential world. History has also shown that once the residential industry became a conforming type industry, it became a more efficient industry and thus more business was executed. So the goal of the small-balance commercial industry is to realize those same results that are already being accomplished and continually trying to improve upon them.
Are there any differences between residential lending
and small-balance commercial lending?
The small-balance commercial lending industry has set a course to make the processes of commercial lending very similar to that of residential lending for the reasons discussed herein, and to a large degree has been successful in that mission. That being said, the biggest difference that exists relates directly to the appraisal process and the associated cost of an appraisal. Commercial real estate appraisals cost significantly more and require more work by the appraiser, thus resulting in a longer turnaround time as well.
The increased time of completion and cost of appraisal when comparing a residential appraisal to a commercial appraisal primarily lies in the fact that the vast majority of information required to complete a residential appraisal can be accessed by the appraiser through online viewing of public records and information with minimal fieldwork required, thus minimizing the amount of time and associated cost to complete a residential appraisal. To the contrary, the vast majority of work that is required to complete a commercial appraisal is fieldwork and due diligence, as public information will only chart a course, as opposed to providing the vast majority of information that is required. Thus, the amount of time and effort it takes to complete a commercial appraisal significantly exceeds that of a residential appraisal.
In addition, while residential appraisals are typically comprised of one approach to value (the sales comparable approach), a commercial appraisal can include up to three approaches to value (cost approach, sales comparable approach and income approach), thus increasing the amount of time and associated cost of the appraisal. The typical cost of a residential appraisal will range from $350-$500 with a three to five day turnaround time; the typical cost of a commercial appraisal will range from $2,500-$7,500 with a typical completion time of three to five weeks.
Another difference to be noted, and very much to the positive side of the ledger, is that unlike the residential industry, the commercial real estate financing industry does not have the Real Estate Settlement Procedures Act (RESPA) requirements.
The small-balance commercial real estate lending industry emerged and evolved not as an industry conforming to the existing guidelines, processes and procedures of commercial real estate finance, but as an industry with its sights set on providing financing alternatives and services that forge new ground and creates a new world of commercial real estate finance. So far, the results impressively speak for themselves. It is estimated that the small-balance commercial real estate industry is currently a $5-$10 billion per year industry with consistent growth seen over the past five years. For those who have found their way into this new world, new opportunities have presented themselves; for those reading this article as their introduction to small-balance commercial real estate lending, "Welcome to the new world!"
Neil Beldock is senior vice president and national sales manager with Westlake Village, Calif.-based Velocity Commercial Capital, a direct institutional wholesale lender. He has more than 20 years of experience in commercial real estate lending. He may be reached at (203) 653-2668 or e-mail [email protected].