At the current time we are living in stormy financial times. The stock market is tumbling, companies are filing bankruptcy, unemployment is rising, and fear is on everyone’s minds.
It is easy to forget in times like this that “this too will pass.” The sunny times will return eventually.
In the current market brokers are having more difficulty providing these items of value. LTVs have decreased, rates have gone up, and many banks are only lending to existing customers.
How does a broker survive and add value in this market?
My post details what questions should be asked when trying to understand the lending programs that a commercial lender has.
Commercial mortgage brokers would do well to take 15 minutes to get acquainted with the lenders on their lender list. While a rate sheet and lending matrix can be helpful, nothing beats a phone or face-to-face interview.
Here are nine questions that will allow a commercial broker to focus their efforts and to target properties to the right lenders.
Imagine that little retail center near your house.You know the one.
It has your favorite coffee shop, the weird home decor shop, a woman’s clothing boutique, the nail shop, and the national auto parts store.
Over the years you’ve seen the stores change. Different shop owners have come and gone. The coffee shop has been there for a while. The woman’s clothing store is only a year old.
As you drive by you notice a “Going Out of Business” sale going on in the home decor shop. You’ve talked with the owner of the woman’s boutique and she is having a rough time making a profit.
If these two stores close their doors, you wonder who is going to fill this space. What is going to happen to the owner of that little retail center? Where will he find tenants?
The Plight of Retail Stores
Americans are spending less money these days. We built our economy upon the model of consumption and borrowed to fuel that consumption.
With the well of cheap financing depleted, spending has come to a screeching halt. Retailers nationwide are taking a hit. The recent headlines have featured the likes of Circuit City, Mervyn’s, Shoe Pavilion, and Linens ‘n Things.
The Pain on Retail Center Owners
When a retail store closes or “goes dark” the landlord will feel the pain of having a vacant store. (Some leases do have a provision that stores can close but while the tenant continues to pay rent.) This means that she does not have as much rental income to pay the bills she faces for owning the property.
How Vacancy and Rental Rates Affect Value
I shared here the most common method to value income producing property. The most important numbers to determine value are Net Operating Income (NOI) and the Capitalization (Cap) Rate.
Rental rates and the assumed vacancy rate will affect the NOI. NOI is then used to calculate the value of the property based on an expected return to the investor, the Cap Rate.
Slight Changes with Devastating Effects
So how would a 10% decrease in rents, a 5% increase in vacancy, and a 1% increase in Cap Rate affect a properties value?
Notice that the value decreases by 26%.
Also notice that the change in the maximum loan amount decreases by $1.08 million. If the borrower needs to refinance under these new assumptions, the borrower will need to come up with over a $1 million to close the loan. The foreclosure process and bankruptcy are not far away.
The Current Credit Crisis
Currently, some institutional lenders have begun to underwrite retail loans along the lines of this scenario. They are forecasting decreasing rents and higher vacancy rates.
Some lenders are incorporating a higher cap rate as well. (One developer I know said that he hasn’t started a retail project unless it underwrote at a 8% cap rate or higher because of historical cap rates, even during the boom times.)
Unless, a retail property absolutely must be refinanced now, the wise real estate investor would be best served to hold off until cooler heads prevail.
Much if not the majority of the news it outside of our individual control. The “winds of destruction” are swirling around our heads.
We can’t stop the winds from blowing. But we can keep our heads down.
You can do nothing anything about macroeconomic problems. You can’t buy enough plasma televisions to save the economy. You don’t control the price of the stock market. You can’t force banks to begin lending.
If you focus on the global economy, the number of unemployed, or the weather forecast for January, you are distracted from the items that you can do today to improve your bottom line.
Focus on Things You Can Control
Focus your energy and emotions on daily items within your sphere of control to ensure that you survive these times. Wasting time and emotions on things outside of your control is ultimately unprofitable.
Focus on Your Attitude
Stay positive. Do not be preoccupied with all that you don’t have. Thinking about toys/gadgets/money we don’t have leads to grumpiness. No one likes a grumpy person.
Rather than focus on what you are lacking, focus on what you do have. Be thankful for things like family, friends, a job, a home, and food. Remember there are always people less fortunate than us.
Focus on Being Productive
What activities can you do daily that will impact sales? Is it phone calls, emails, or personal visits? Focus on completing these tasks. Focus on meeting people, generating referrals, and results.
When will you do these activities on a daily basis? Plan the activities that are profitable into your calendar. Block time in order to attain the results necessary. Turn off the phone. Don’t check your email. Stay on point and accomplish your goals. (Even as I write this I am being distracted by something.)
How many [blank] do you have to do to generate the income that you want? If you reach 5 people a day will it generate the income you want? Do you need to phone 10 people a day? If you email 200 people a month will it generate the results you need?
Focus on Adding Value
If you constantly seek to add value as an employee, as a salesman, or as a consultant you will be rewarded for the value you add.
Too often we are myopic and only think that the item we sell adds value. However, we can add value by relaying good information, referring a new customer, or by offering insight. All of these can be done at no cost to our clients, yet it endears them to us. Caution: Don’t expect to get something in return immediately.
What value are bringing to your boss/client? You are only worth the value you add!
Get Back to Work!
It is easy to see that in these coming times, work will win the day. Those that work harder and perform at a higher level will be rewarded.
The “Times of Plenty” are over. Now by the sweat of our brow we will have to generate income.
Don’t let the negativity distract you from production, staying positive, and adding value.
Part of my job is to take incoming cold calls. We advertise in a commercial lending industry magazine that generates a good deal of call traffic.
On a regular basis I get requests for “construction” loans. After asking some questions to determine the nature of the loan, I usually find out that the broker/borrower is actually searching for what I would call a “development” loan.
What’s the Difference, Who Cares?
Why does it matter if you call it a construction loan rather than a development loan?
First, it reflects on the broker/borrower. If a lender has to educate the person requesting money, it sets a bad tone for the deal.
Second, some lenders offer construction financing but don’t offer development financing. Asking the right question allows you to get a correct response and save you time.
Finally, loan to value and equity requirements may vary depending on whether the loan is for development or for construction; I know ours do. This information helps the lender determine if the loan is within their parameters.
Construction vs. Development
Construction by definition has the connotation of putting things together. In my mind, moving dirt for roads or infrastructure does not meet this definition (no offense to those in the fields of civil construction).
The definition of the word develop includes the idea of being made usable. This is perfectly suited for the installation of roads, pads, and infrastructure; as the land has now been made usable for a building.
Defining Loans
Consequently, I would recommend that if you are asking lenders for a construction loan, a building should be in place when construction is complete.
Loans to improve land should be titled as development loans.
This the third post in a series I am writing on finding distressed properties. Posts 1 & 2 can be found here.
Marketing
Marketing to owners of distressed property is the third method of finding distressed property.
Marketing Costs
For purposes of this post we will define marketing as the process of informing owners of distressed property, that you are interested in purchasing their property.
Almost all forms of marketing will have an out of pocket cost, before you see a return on the marketing investment. These costs may include printing, postage, design, or mass media expenses.
Marketing Budget
It is important to prepare a marketing budget prior to investment in any system. A budget will help you track marketing effectiveness and control spending.
Consistency is key to any marketing strategy. Most marketing takes time to show results. Dividing your marketing budget over months or weeks, will help to develop consistency and prevent you from “betting the ranch” in one marketing blast.
Market to Your Sphere
Each one of us has a sphere of influence that we touch on a regular basis. Our sphere includes friends, family, neighbors, clients, employees/employer, service providers, etc.
The easiest way of informing your sphere of influence that you are in the market for distressed property is through the use of business cards.
Business cards are an inexpensive way of informing others of who you are and what you want. By including a list of desired property characteristics on the back of the card, you remind the holder of what you are seeking.
Direct Mail
Direct mail consists of mailed advertisements to potential sellers. Direct mail is a proven marketing method, but has in general only a 2% response rate.
Printing and postage costs are both associated with direct mail. If first class postage is used, costs can be in excess of $0.50 per marketing piece. These costs add up very quickly and may limit the number of people you are able to reach.
Direct mail will have a greater efficiency if it can be targeted to individuals that have been pre-screened for relevant criteria. Criteria that may be helpful could include property owners, age of property, length of ownership, and building age. Title companies may be able to provide this information to you.
Signage
Bandit signs, fliers, and other types of signs can be used to garner the attention of would be sellers. This type of advertising is more likely to be utilized for residential properties than for commercial properties.
Fliers with your commercial property description could be distributed to local commercial brokers. This may be a way to inform the brokerage community of what you are searching for.
Classified Ads
The classified ads of your local newspaper may be a cost effective means of advertising your desire to buy distressed property.
Typically, those reading the classified section are in search of something specific. Classified users tend to be in the market.
A classified ad stressing that you buy real estate of all shapes and sizes may draw the attention of someone in need of selling or tired of dealing with tenants.
Mass Media
Mass media includes radio, television, and billboards. Though these methods have a broad reach, not everyone that sees or hears your advertisement will be a suitable customer. Thus, in general they are not a cost-effective means of advertising for distressed properties.
Conclusion
While there are many different marketing channels, you must find the method that works best for your property characteristics and fits within your budget. Once a channel begins to produce results, you should re-invest in that channel in order to produce even greater results.
Marketing takes time and requires consistency. Invest in marketing over the long haul in order to reap the rewards.
While I mostly deal with commercial real estate, I like to know what is going on in the housing market as well. Today's news had two interesting articles that I enjoyed reading.
First, Reuters has an interesting article about the residential real estate market in Stockton, CA. Stockton is about an hour away from beautiful Walnut Creek, CA. As you can read in the article Stockton has been devastated by the bursting of the real estate bubble. The article reports that some agents in Stockton are almost telling home owners not to sell because the market is so poor.
Second, the L.A. Times blog is reporting that developer Michael Crews Developmentis was offering a buy one get one free special on homes in San Diego County. According to the literature the promo ended May 31, 2008. Of course the L.A. Times reported it on June 1, 2008. (HT: Drudge Report)
When I am reviewing a loan file one of the first things I look at and look for is the executive summary or loan summary. A well written executive summary speaks to the quality of the borrower and the value of the project. The goal of well written loan summary is to give the underwriter enough information to understand the commercial loan and to determine if the loan will fit within the lender’s lending guidelines.
Below are items that should be included in a well written and complete executive summary.
Salient Facts
Lenders want to know the details of the commercial real estate loan. Property location, property type, number of units, lot size, and the square footage are all important in the underwriting process.
Also include the loan amount and property value. I am always amazed when a loan summary is missing the loan amount or the property value. If the property is being acquired, include the purchase price.
You might also include useful ratios such as loan-to-value (LTV), loan-to-cost (LTC), and the debt-service coverage ratio (DSCR). Rounding these ratios to the nearest 5 or 10 integer can appear deceiving. I personally prefer that these ratios be expressed to two decimal places.
Project History
Include a project history for commercial property that is currently owned by the borrower. This should include the date of acquisition, acquisition costs, and any improvements or monies spent on the project.
Exit Strategy
Owens Financial Group is a bridge lender. Consequently, we are looking to see what the borrower’s strategy is to repay our loan at the end of the loan’s term. The exit strategy may be less important to permanent lenders than to short-term sources of capital.
Sponsor Summary
The sponsor or borrower summary should give relevant facts about the sponsor, but should not be their life story. A more detailed description of the borrower or borrowing entity can be include in a borrower’s resume.
A good summary might look like this:
Fictitious Development Company was started in 1989. Since it’s inception it has developed 32 properties with over 1,000,000 square feet of retail space. With combined sales of $120 million.
Or:
Fictitious Properties Group began acquiring multi-family properties in 1993. Fictitious currently owns in excess of 4,000 units in 7 states with rental revenue of in excess of $3,000,000.
Sources and Uses
This section details the utilization of the loan proceeds as well as the source of any other funds needed for the project. A table or spreadsheet format is most helpful and looks cleaner. If you are seeking a construction loan, this section is vital for the underwriting process. Cost information should only be a summary, because this is the executive summary and not the supporting detail, . The detailed costs should be included with the rest of the packet.
Property Financials
Relevant information regarding the current or projected rental income of a building should be included. The value of income property is determined by dividing the property’s net operating income by a capitalization rate suitable for the market location. Gross Income, total expenses, and vacancy are needed to determine net operating income.
Conclusion
Keep an executive summary short, no more than two pages. Include enough detail for the underwriter to understand the deal and to determine if it will fit in the lender’s parameters. Never mislead or lie on an executive summary. A well written commercial loan summary is often a reflection of the professionalism of the commercial mortgage broker submitting the loan.
I field phone calls from commercial loan brokers all day long discussing the different loan scenarios that come across their desks. Our company advertises in the Scotsman Guide and this generates some “cold” incoming calls.
Frequently, we will get a phone call from a Broker A that received a loan file from Broker B. Broker B received the file from Broker C who received it from Broker D who knows the borrower. This is what we call a broker “daisy chain”.
Merriam-Webster defines a “daisy chain” as “1) a string of daisies with stems linked to form a chain, 2) an interlinked series”. One broker linked to another broker linked to the next broker, etc.
Problems with Daisy Chains
Human nature dictates that every broker involved in the transaction feels entitled to a piece of the pie. Each will often demand their own “fee” for services rendered. Often this is a deal breaker. If there are four brokers in the deal each charging a 1% fee the borrower is now paying a fee of 4% just to brokers! As Brian Bradywrites , “what value does the agent bring to a transaction” to demand a fee?
If the borrower balks at the fee, Broker A is likely to say to Broker D, “I know the lender, you know the borrower, if we cut out B & C the fee is only two points and the borrower gets his loan closed.” Now Broker D is in an ethical dilemma, because he plays golf with Broker C on Wednesdays. Does he get the loan closed and burn Broker C to earn the commission?
Let’s imagine that this is a perfect world and all of the brokers in the deal lower their fee to an amount acceptable to the borrower. However, they are unwilling to give up their contact in the chain for fear of a future “circumvention”. So every piece of information needs to be passed from the borrower to Broker D to Broker C to Broker B to Broker A to the lender. (Did you ever play the game Telephone as a kid?)
How to Avoid Daisy Chains
Ask if the hard money lender lends their funds. Or you may ask if the hard money lender brokers their deals. Both of these questions should give you a better insight into the lender’s business model and how they make loans. If a “lender” brokers all of their deals, you may get caught in a daisy chain. Ask enough questions to get a straight answer and to understand the lender.
Remedies for a Daisy Chain
The smart broker that finds herself in a daisy chain situation will take control of the situation and work as the main point of contact for both the lender and the borrower. For example the chain of brokers lowers their fee to 2% of the loan amount. Broker D volunteers to coordinate between the lender and the borrower for a larger share of the commission, say 1%, allowing the other three lenders to split the remaining 1% without having to do any additional work.
Cutting out a broker from a deal, because they do not have a “signed agreement”, is a bad idea. This is a quick way to ruin a reputation and to never receive a referral again.
Summary
Daisy chains should be avoided at all costs. However, if you find yourself in the midst of this situation, take control and work to bring the deal to completion. This is an opportunity to gain a reputation as a broker that gets things done in the eyes of the borrower, other brokers, and the lender.
Disclaimer: ActiveRain Corp. does not necessarily endorse the real estate agents, loan officers and brokers listed on this site. These real estate profiles, blogs and blog entries are provided here as a courtesy to our visitors to help them make an informed decision when buying or selling a house. ActiveRain Corp. takes no responsibility for the content in these profiles, that are written by the members of this community.
;)
;)
