Waad Nadhir has been in the real estate business since 1989 and is an expert when it comes to real estate financing.
There are two big differences between commercial and residential financing of properties.
Lenders look at residential properties as personal residences. To qualify for a residential property loan, you need to show your creditworthiness first.
Lenders view commercial properties differently. They know that a commercial property is a place of business, which is why they are first interested in the ability of a commercial property to generate income. Your primary goal when seeking to finance for a commercial property is to show that it will bring more income than it will take in expenses and mortgage payments. Your personal qualifications come second. This means that in certain situations you may have less than ideal credit history, but your income-generating property may allow you to get a loan.
Another difference between commercial and residential real estate has to do with the down payment amount. Commercial properties typically require a down payment of at least twenty percent of the purchase price. Zero-down loans and mortgages are almost unheard-of in the commercial real estate industry. In addition to this, because the loans for commercial real estate are usually much bigger than the residential loans and the risks are higher, the rules are much stricter.
When analyzing the income from a commercial real estate property, lenders look at debt coverage ratio and loan-to-value ratio.
Debt coverage ratio is the ratio of net operating income from the property to the debt payments. Fundamentally, this ratio shows whether the property is bringing enough money to cover the debts for which it serves as collateral. The loan-to-value ratio compares the appraisal value of the property to the loan amount. A typical loan-to-value ratio incorporates the income strength of the property and the financial health of the buyer. While experienced real estate investors like Waad Nadhir may be able to make a deal because of their reputation, newbie investors need to pay very careful attention to the numbers.
Waad Nadhir has been president of BOSC Realty Advisors since 1989.
Many people think that getting real estate financing is similar to signing a lease on a piece of real estate. Someone who grants a lease is a lessor or the landlord. Someone who takes on a lease is the tenant or lessee. People then assume that when they get a mortgage from a bank they are a mortgagee, the bank is the mortgagor, but this is not how real estate financing works.
Generally speaking, when you want to acquire a commercial real estate property, you do not have the necessary amount of money in order to do so. Even if you do have the entire amount in cash, it is often not smart to part away with it because you lose leverage and cash that you could use to make other deals happen.
Banks have the money that you need, but they have no interest in buying the property on their own. This means that you want to buy the property but don’t have the necessary amount of money and a bank has the money but doesn’t want to buy the property. You then go to the bank and essentially give a pledge to return principal with interest if the bank helps you. This pledge is called a mortgage. You are the one giving a pledge, which makes you a mortgagor and the bank is the recipient of the pledge, which makes it the mortgagee. You are providing a bank with a mortgage in exchange for a given amount of money.
Here’s why this is important: many people think that when applying for a mortgage, they are asking a bank for money. In reality, you are not asking for anything, but you are offering to make a deal. There is a big difference in asking your friend for an expensive piece of equipment that you could use during your vacation and asking to store your Bugatti in your friend’s garage while you are away.
You will feel very differently when you realize that you are not asking for money, but are offering a pledge to the bank.
Once you make your offer, you bankers will want to know what they will get if they choose to make a deal with you. They also want to know the level of certainty that the deal involves. For example, if the property is fully leased and comes with a rental income, then you want to communicate the numbers to your bank. Bankers know that your ability to pay off your mortgage depends on the length of your leases and quality of your tenants. Finally, tell your bankers about the cash flow surplus. Do not create a lengthy spreadsheet. Rather, summarize everything in a few sentences to build confidence that you are a wise investor who is offering a great deal to the bank just like Waad Nadhir would do.