For those of you just getting started in commercial mortgage brokerage, this is a particularly important training article; however, even those of you who are very experienced in brokering commercial loans may find some useful nuggets.
The scenario: You get a lead call for a commercial loan. The borrower needs a $1.2 million refinance on his self storage facilty in Provo, Utah. The borrower is on the phone right now, and he wants a loan quote. What interest rate do you quote him? If he likes your quote, he may want to get started right away. What documents do you ask for? As the mad bomber asked Keanu Reeves in the thriller, Speed, "Pop quiz, Hotshot, what do you do (quote)?"
This is a small commercial loan, one that is unlikely to be made by some big national lender. You're located in Sacramento, California, and you have no idea to which commercial lender you will eventually take this deal, but you do know that the best lender for the deal will probably be located near Provo, Utah. After all, banks greatly prefer to lend close to one of their branches.
- Here's the good news. Most banks across the country charge roughly the same interest rate on commercial loans. They are almost always within 0.25% to 0.50% of each other. Therefore you don't need to know precisely what some bank in Provo, Utah is going to charge. You just need to know what a Sacramento bank would likely charge on a $1.2 million permanent loan on a self storage facility close to Sacramento. In practice, the two different banks - even though they are one thousand miles away - will charge almost exactly the same thing.
- Okay, but what would a Sacramento bank charge for a commercial loan on a property in Sacramento? This one is simple: Simply go to the Current Commercial Mortgage Rates page on CommercialMortgageRates.co. (Note, this is a dot-co, not a dot-com. The owner of the dot-com version wanted thousands of dollars for the domain.) I update these rates weekly, so they are very current. STOP! Before you step away for coffee or you go to the bathroom, please be sure to bookmark this page. Please do not read further until you have done this.
- "Okay, George, I see from the rate sheet what interest rate I should quote, but how many points should I quote?" Commercial banks typically charge only one point on commercial loans, so you, as a commercial loan broker, will need to add your loan brokerage commission on top. Here is a training article I have written about the size of a reasonable loan brokerage commission.
- What amortization should you quote? A twenty-five year amortization is to commercial mortgage finance what a thirty-year amortization is to residential mortgage finance. The vast majority of all commercial loans have a 25-year amortization. If a commercial property is older than 40 years old, the bank may even insist on a 20-year amortization. After all, a commercial property does not have an unlimited lifespan. A thirty-year amortization, however, is common for multi-family properties.
- What about the term of the loan? Most banks would greatly prefer to write their commercial loans with a term of just five years, but if they are pushed, most banks will agree to a ten-year term. Certainly most commercial borrowers will insist on a loan term of at least ten years. Commercial real estate loans with terms longer than ten years are only possible on SBA loans and USDA loans - government guaranteed commercial loans which are eligible to be re-sold by the bank in the secondary market. Remember, most conventional commercial real estate loans are portfolio loans. In other words, the bank is stuck with that commercial loan for the entire ten years.
- Will the interest rate be fixed or adjustable? Almost all commercial loans these days are fixed rate loans. (In two years, when the inflation rate and interest rates start to climb, this may change.) You are NOT going to get a straight, ten-year, fixed rate commercial loan from a bank. The loan will most likely be fixed for the first five years. Then it will readjust just once at the beginning of year six "to a market rate." Then the typical bank commercial loan will be fixed for the remaining five years. What will be the index and the spread over the index? This may shock you, but most bank promissory notes are silent on the subject. The bank will typically use language like, "Whatever rate the bank is currently quoting on similar commercial loans." Don't worry about it. I have never had a borrower raise the issue.
- What about a prepayment penalty? Most banks have a modest prepayment penalty on their portfolio commercial loans. The one you will most often see - and the prepayment penalty that you should quote is - 5% in year 1, 4% in year 2%, 3% in year 3, 2% in year four, and 1% in year 5. There will typically be a three-month window after the rate readjusts one time at the beginning of year 6, during which window the loan may be paid off without penalty.
- What about assumability? Bank commercial loans are NOT assumable and must be paid off when the property is sold.
You now know how to quote a commercial loan. Voila!
Okay, the borrower is interested, and he wants to know what documents that he should send you.
- Now an idiot would ask his borrower to send him a long laundry list of items, and that idiot loan officer, if he is on commission, would surely starve. Borrowers don't enjoy fetching huge piles of documents. They will look for any excuse not to gather it right away. In the meantime, some competing commercial mortgage company is likely to quote the borrower 2% interest, fixed for fifty years, with a negative two points, and 150% loan-to-value. The competing quote is obviously BS, but guess which loan officer is going to get the borrower's loan application?
- Here is a rule that I pound into the heads of my loan officers, "The loan officer who asks for the least number of documents wins the deal."
- Perhaps the best way to ask for documents is as follows, "Please send me whatever package you can send me right away, as long as it includes: (1) a Rent Roll or Schedule of Leases; (2) last year's actual operating expenses; and (3) color photo's on the property."
- The idea is to get the borrower moving in your direction. He's at rest at the moment, and the Law of Inertia says that a body at rest tends to stay at rest. If you can get him to send you the tiniest of packages, he becomes a body in motion, and a body in motion tends to stay in motion.
- Once you get the income and expense numbers, you can whip up a quick Pro Forma Operating Statement. At today's low interest rates, just about every commercial loan cash flows very adequately, so then you can call the borrower back and ask for the next round of documents. "Great news, Mr. Borrower! I crunched the numbers on your deal, and the numbers worked out well. Now all I need is an old financial statement and two years' tax returns."
- Remember this important rule, "The commercial loan officer who receives the borrower's tax returns first wins the loan." But wait, George, shouldn't I then ask for tax returns right away? No! Borrowers dread standing in front of a copy machine for 20 minutes and making copies. They need the postitive reinforcement of you crunching the numbers first to get fired up enough to copy their tax returns.
- Armed with the cash flow numbers and the borrower's financial statement and tax returns, you now have enough of a package to start submitting your deal to lenders. That will be the subject of a future training article.
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Do you need a lender who will allow a negative cash flow? Do you need a lender who will also look at the borrower's global income - income from salaries, other investments, etc.? Do you need a lender who will allow the seller to carry back a second mortgage? Does your client have a balloon payment coming due on his commercial property? Has your bank offered him a discounted pay-off? Does your borrower have less-than-stellar credit? Is your client's company losing money? Is your borrower a foreign national? Do you need a non-recourse loan? Do you need a commercial loan with no prepayment penalty? Is your client's commercial property partially vacant? Do all of your commercial leases run out in the next 18 months?
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