Lenders see hundreds of loan financing requests each month and apart from a referral from a trusted source, the documents you submit for financing are the only basis they have for deciding whether they are interested in providing financing to you. With so many opportunities, most lenders simply focus on finding reasons to say no, because in the lending business, protection of their capital in the number one priority.
Any one or several of the reasons listed below may cause a lender to reject your loan application. Here are the most common reasons:
Value inflation
On many occasions, borrowers come to us and say they are buying a property for $X but it is appraised for $Y which is many times higher than the purchase price. We usually see this primarily with land development deals where the borrower wants to get a loan based on the appraised value which would allow them to purchase the land and finance the construction. They are essentially trying to get 100% financing. This is an indication that the borrowers do not have enough equity to purchase the property. Most lenders will only lend on the lessor of the purchase price or appraised value.
Wanting the lender to conform to your terms
This is one of the most common reasons why commercial loans don’t get funded. I cannot tell you how many “borrowers” come to us with their list of terms of what they are “willing to pay” to get a loan on their commercial property and they are just not willing to budge off their requirements. Let me tell you something, folks — the lender is the one that controls the terms, not the borrower. There are billions of dollars of private money being invested in commercial mortgages and lenders still control the deal flow. After all it’s their money. Remember the “Golden Rule.” He who has the gold makes the rules!
Not willing to pay lender fees
Let’s get this understood once and for all: lenders charge fees. We get lots of prospective borrowers coming to us and stating up front, “I don’t pay up-front fees.” Great! We don’t charge up-front fees, either. However, someone must pay for the up-front expense of underwriting your loan.
In any given transaction, the Client will be responsible for paying the Legal Fees, Appraisal Fees, Feasibility and Marketing Report fees, Environmental report fees, Quantity surveyor fees, Land surveyor fees, Site visit costs and any other fees related to due diligence and background checks. Most lenders will require you to pay a lump sum amount into an escrow account and then the fees and expenses are billed to that account. At closing the borrower will get credit for the monies paid and they will get a full accounting for the monies spent. This is similar to how a law firm works when engaged to do legal work on behalf of a client. Lenders prefer to do things this way so that there are no delays in getting the loan funded. Some lenders may allow the borrower to pay the fees/costs directly to a third party for the expenses incurred however this may result in a longer time to get a loan funded.
Did you know that lenders underwrite hundreds of loans that never get to funding because the borrower has misrepresented some fundamental aspect of their deal? Lenders expect you, the borrower, to put down some money in advance of loan closing to show the seriousness of your intent to actually close the loan with them. They call this a ``commitment fee``. A lender will charge you 1-2 points up front to cover the cost of underwriting your loan. So, if you want to get funded, get with the program and quit telling lenders what you will and won’t do. The second reason why lenders require a commitment fee is so that you do not ``shop`` the loan around while they are working on arranging your financing. No lender wants to put in the effort working on your loan only to have you go and get the loan from somewhere else. It is a waste of everyone's time and effort.
Borrowers that insist on paying absolutely nothing until funding will never get funded, it takes money to borrow money. Liquidity or cash on hand is definitely going to be required, and varies widely from lender to lender. Be prepared to pay lender fees/costs of some form.
Too much debt / too highly leveraged (not enough equity)
Occasionally, we get a request from an experienced investor who is looking to either refinance an existing property or add another property to his or her portfolio. The challenge we see here is that they are often too highly leveraged. All of their existing properties have mortgages at the maximum loan to value and there is very little additional equity that might be available to provide back-up cash flow or additional collateral to the lender. Lenders see this as a risky position because if one property develops a problem, it could potentially cause the entire portfolio to be at risk.
Not enough liquid assets
In addition to the reason given above, some borrowers come to us and they have a substantial personal net worth, however they have very little liquid assets. In many cases, especially with experienced real estate investors, their net worth is made up primarily of real estate assets which is an illiquid asset. Therefore, if one of their properties has a major problem, such as the basement flooded and they have to replace the furnace, or the roof got damaged in a storm etc., how are they going to pay to fix it if they do not have enough liquid assets (cash, stocks, mutual funds, bonds) that they can use. Lenders see this as having a “weak” net worth. Your loan would get turned down on this basis, because the lender would consider it to be too risky.
Not being prepared with the right paperwork/ documentation
If you own a commercial property, you must keep separate books on each property you own. Period. End of conversation. We’ve seen a number of investors who hold property in their own name, don’t pay themselves to manage the property, don’t keep records of their tenant leases, don’t charge themselves rent if they personally occupy the property, and co-mingle funds with their personal accounts. When it comes to commercial loans, lenders want to see a clear and accurate history of the property’s performance. They need to know that the property alone can support the costs of servicing and repaying the debt. If you cannot provide historic profit and loss statements, rent rolls, details of capital improvements, as well as your own personal financial statements (excluding the property being refinanced), then you will likely not get funded.
Insufficient cash flow from the property
Another big mistake that commercial property owners make is overstating their income from the property and understating the true expenses. Lenders want to see that the property can support the amount of debt the borrower is seeking. Pretty simple. They do this by calculating the Debt Service Coverage Ratio (DSCR). DSCR = Net Operating Income / Annual Debt Service. The two biggest mistakes we see here are i) not subtracting a vacancy allowance from the Gross Rental Income; and ii) not adding a property management fee when you manage the property yourself. Change these two numbers and you may discover that your property actually doesn’t cash flow to cover the amount of debt you are seeking.
Asking for too high a loan amount
Some borrowers have unrealistic expectations about how much debt they can put on a commercial property. Unlike residential property, where you can usually borrow 80% of the property value in first mortgage, commercial lenders will loan 65%-70% LTV (loan to value.) If you are buying a property, some commercial lenders allow the buyer to carry a 2nd mortgage on the property; however, they require the borrower to have at least 10% “skin in the game”. For most of the commercial property owners whose income is generated by leases to tenants, you are limited in the amount of money you can borrow. Asking for more than the maximum LTV will cause your loan to be denied.
Lack of experience with commercial property
We often get requests for loans from people who are beginning their career investing in commercial real estate. If you are inexperienced in commercial real estate, or are new to investing in a particular asset category, the best thing you can do is partner with someone experienced in managing this type of property. There are any number of problems in the day-to-day operations of your property and an experienced manager is your best insurance against fraud, lazy employees, costly expenses or missed income opportunities. Your loan would get turned down on this basis unless you had someone with good experience on your team.
Sales and Marketing strategy is not clear - No go-to-market strategy
For new construction projects, the borrower’s business plan fails to explain the sales, marketing, and distribution strategy. The key questions that must be answered are: who will buy it, why, who is your competition, what is the best price to sell it at, and most importantly, how fast will the sales occur (called absorption)?
For larger projects, a Feasibility study done by an independent third-party firm will be required in order to address these concerns. In many cases borrowers come to us after ``shopping`` their loan to many lenders without understanding that the reason why they keep getting denied a loan is because they do not have a proper Feasibility study which shows there is a demand and need for the type of project they want to build.
You must explain how you have already generated customer interest and obtained pre-sales – and describe how you will leverage this experience through a cost-effective go-to-market strategy.
Exit strategy is not clear
Borrowers must be able to clearly show the lender how they will be repaid their loan. This could be from sale of the building on completion of construction, sale of the individual units, generation of sufficient rental income over several years to easily refinance the loan or pay it off in full etc. If you can’t demonstrate to the lender how they will be repaid their loan then you will not get the loan.
Executive summary too long
Lenders are very busy, and do not have the time to read long business plans. They also favor borrowers who demonstrate the ability to convey the most important elements of a complex idea as simply as possible. An ideal executive summary is no more than 1-5 pages. An ideal business plan is 20-30 pages (and most lenders prefer the lower end of this range).
Remember, the primary purpose of a business plan for a loan request is to motivate the lender so that they want to fund your loan. It is not intended to describe every last detail. Document the details elsewhere: in your operating plan, marketing plan, feasibility study etc.
Too repetitive
All too often, a business plan covers the same points over and over. A well written plan should cover key points only twice: once, briefly, in the executive summary, and again, in greater detail, in the body of the plan.
Poorly organized and lack of specific details
Your presentation should flow in a nice, organized fashion. Each section should build logically on the previous section, without requiring the reader to know something that is presented later in the plan.
Too many executive summaries contain mainly ``marketing fluff`` of pictures and hype and with very little detail on what is important, which is: what are you going to do with the money you borrow, how you are going to make money to be able to repay the loan and what previous experience do you have with that type of investment.
Unrealistic financials and insufficient financial projections
Basic financial projections consist of three fundamental elements: Income Statements, Balance Sheets, and Cash Flow Statements. All of these must conform to Generally Accepted Accounting Principles (GAAP).
Lenders generally expect to see five years of projections. Of course, nobody can see five years into the future but the lender primarily wants to see the thought process you employ to create long-term projections and if you used reasonable assumptions. An example of wrong assumptions would be running at 90% occupancy on a hotel every year or underestimating your food and beverage costs for a restaurant or factoring in unrealistically high annual rent increases for an apartment building.
“We have no competition”
No matter what you may think, you have competitors. Maybe not a direct competitor – in the sense of a company offering an identical product – but at least a substitute. Fingers are a substitute for a spoon. First class mail is a substitute for e-mail. A coronary bypass is a substitute for an angioplasty. Competitors, simply stated, consist of everybody pursuing the same customer dollars. To say that you have no competition is one of the fastest ways you can get your plan tossed – lenders will conclude that you do not have a full understanding of your market and you don’t know what you are doing.
Lack of understanding of the lending parameters
We facilitate loans primarily from private sources. Unlike banks that bundle their loans and sell them on Wall Street, these private lenders are portfolio lenders. Their first concern is the monthly loan payment. Does the property have sufficient cash flow to handle the monthly debt service? Their 2nd concern is the property’s ability to repay the debt principal over time. If you, the borrower, came to us and tried to sell the merits of the deal based on how great the property is, how terrific you are as a person, how much you’ve already invested, or how much interest you’re willing to pay, you’re not going to get anywhere. The lender is not very interested in these things. Know your lending (and borrowing) basics!
Asking the wrong person to get the loan for you
Probably the second biggest reason that we’ve seen perfectly good commercial loan request go south and never get funded is taking the deal to the wrong person. Generally, this person represents themselves as someone who can get you a commercial real estate loan. Ask them a key question, “Are you direct to the money?” We get a lot of intermediaries bringing us deals. Sometimes they have a second intermediary who brought them the deal. We charge a 1 to 2 percent fee, at closing, as our success fee. We are direct to lenders, these lenders charge 1 to 2 points (at closing) for their efforts in getting you the loan that you need. Some of these “brokers” will charge you 2 points for their efforts. Their intermediaries (the person you brought your deal to) charge you 2 points. Come on, folks, you do the math! By the time the deal gets to the actual person who can make the loan, it has gotten so expensive for you, the borrower, that you will never want to close on this loan. Similarly, don’t bring your loan request to your accountant, your attorney, your neighbour, your friend, or someone you heard about from some other source. Bring your loan to the people who can actually get it done for you!
Going to the wrong lending source.
The number one reason why, in our opinion, commercial real estate loans get denied is that they are not brought to sources that can actually fund them. Most often, if your deal has been turned down, it is likely that you brought it to a bank, credit union, or other mortgage lender, that a) doesn’t do commercial loans; b) doesn’t do your particular type of loan; or c) has no room in their current portfolio for your loan. Banks, etc. are regulated by FDIC, Fannie Mae, Freddie Mac, CMHC, CDIC etc. These oversight agencies regulate not only the rate and term that banks can offer you, but also the mix of loans they can hold on their balance sheet.
Here are some mismatches we’ve seen – stand-alone single tenant buildings e.g. restaurants or non-flagged hotels (too many in the lender’s portfolio); rural apartment building (not enough population density for major banks); depressed economic area (most banks not lending there.) Other reasons banks won’t lend to you no matter what - property underperforming-expenses are too high; need a discounted payoff; wrong asset category (e.g. no car washes or golf courses); Government tax lien issues; property taxes in arrears; vacancy rate too high. In other words, if your property isn’t “perfect” banks are more likely to turn you down.
Till the next time
Bruce
Northern Range Capital Corp can help you with your commercial property financing needs. We have a proprietary database of lenders that we have compiled over the years which allows us to easily find the best and most appropriate lender for your project. We can structure your loan request so that the lender sees the merit in your project and wants to have a more detailed review. Give us a call to discuss your project requirements.
