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The Commercial Construction Lending Process

by Self Published Articles

Commercial Construction Lending

By Paul Long –  February 2019

Sometimes when you can’t find that perfect building for your business, it is possible to build your own. Not everyone has the cash in the bank to do that, so going to your local community bank is a great option. This article will talk about the basics to commercial constructions loans, residential construction lending is a little different, so talk with your residential lender for more information about that process.

What I hear from borrowers that have done a commercial construction project before is, “Its not going to be easy.” In construction projects there are things that can go wrong during the process. Items are not delivered as you expected, subcontractors don’t show up, you decide to make a change after the drawings and it costs more, change orders etc.  On the other side after you go through all of this hard work, you have a property that is exactly what you wanted for years to come. It is my hope that sharing the information about this process will help you understand, it so you have all the information to make a proper decision.

Before you start a construction project and before you purchase the land, see how much land you need and in what location. Do you plan on paying for the land in cash or do you need a land loan? What is important to know is that land loans are tough to get through banks, generally banks look for 40% down and the land should have all the utilities needed for your project already on site. Banks generally will give you a land loan for 12-24 months, during this time you need to get your project ready for construction. Some things to think to have prepared are:

  • Plans- Work with a local architect to build the plans for your project.
  • Budget- Have at least two bids from local contractors on how much they believe the project will cost by each line item.
  • Feasibility– A feasibility study is an analysis of how successfully a project can be completed, accounting for factors that affect it such as economic, technological, legal and scheduling factors.
  • Zoning- The process of dividing land in a municipality into zones (e.g. residential, industrial) in which certain land uses are permitted or prohibited.
  • Permits– Check with your city, state and county for construction permit requirements.

Now that you have the land and the details taken care of, it is time to go to the bank and start the process of a construction loan. Banks will ask for this information above before starting the loan process.

It is now time to determine how much money you need to bring to the project. Each bank may have a different policy as to how much equity you need for your project. Generally, the bank will loan up to 85% Loan to Cost (LTC- Loan amount divided by cost of the project) and 75% Loan to Value (LTV- Loan amount divided by the anticipated value of the project)

  • Cash down payment on the land purchase or equity in existing land can be used as equity.
  • Project equity could come in the from a separate piece of real estate that isn’t involved in the construction project.
  • Any pre-paid soft costs (architectural, engineering, legal fees, and other pre-construction expenses) can be included as equity.
  • If cash is required for the project, funds will be required to be paid at construction loan closing.

Loan Structure/ Process/ Credit- Underwriting

Structure: The bank will structure the loan to have a 6-18-month construction period where there are Interest only payments during construction phase. The interest payment generally will come from interest reserves that are in your construction budget until depleted or converted to a permeant loan. Generally, after an occupancy permit is issued, the loan is converted into a conventional commercial term loan at a predetermined interest rate.

The Process:

Many people ask me “what should my personal financials look like” before taking on a construction project and this is as important as what you are building. Borrowers should have a credit score above 700, due to the risk of construction lending credit history is very important. Also, your experience doing these projections in the past is also favorable, however if you are using a general contractor (which I hope you are) the bank will underwrite them to make sure that they have experience building projections that are comparable to yours.

Because constructions projects can go over budget banks will put in 3-10% contingency in the budget, but in the rare cases where that is fully used, the bank will come back to the borrower for an additional cash infusion. That is why we suggest borrowers having net worth greater than $750,000 and extra cash of about $50-$150 at minimum is also suggested. Finally, the borrower needs to have stable recurring cash flow from employment or self-employment to also assist with additional cash if needed.

There is much more to a commercial construction project so feel free to check out my Construction Lending Overview Sheet here which can give you additional information on the process. You can also reach out to me or your local community bank for more information.

Having your own building that you built to your specifications is great, but like most things in the world all good things take time, hard work and patience.

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Using Commercial Loans to Fund Your Real Estate Investments

by Helpful Articles & Tips

by Kevin Perk

Unless you are sitting on a pile of cash, the purchase of your buy and hold properties are going to have to be financed through some type of loan.  The first few loans for your investment properties are relatively easy to get.   We will call these types of loans “traditional” financing.  Just shop around with any bank or mortgage broker and they will likely be able to help you buy that first, second, third and perhaps even fourth rental property.

After that, getting “traditional” financing becomes much more difficult.  Most “traditional” lenders will cut you off.  They will tell you that you no longer fit their criteria.  You have “too many” properties.  The real problem is they cannot sell these loans on the open market.  But you want to keep investing and growing your business.  You would eventually like to quit your “real” job.  So what can you do?

One of the biggest struggles that many new investors have is in coming up with the money to purchase their first real estate properties. Well, BiggerPockets can help with that too. The Book on Investing in Real Estate with No (and Low) Money Down can give you the tools you need to get started in real estate, even if you don’t have tons of cash lying around.

Click Here to Download

How to Purchase Real Estate With No (or Low) Money!

What are Commercial Loans?

One thing you can do is try can get commercial loans.  These loans are different from more “traditional” financing and can help the smaller (and larger) investor grow their investing business.  Commercial loans are different from more “traditional” sources of funding in several ways.

  • Commercial loans are generally found at smaller, community banks.
  • Commercial loans are often held in the bank’s own portfolio, rather than bundled and sold on the open market to Freddie Mac or Fannie Mae for example.
  • Commercial loans offer much more flexibility with ownership, property type and number of properties owned.  With commercial loans, you can actually title properties in your LLC for example.  You can’t do that with “traditional” financing.

How to Get Commercial Loans

Commercial loans used to be very easy to get before 2008.  Now they are much more restricted, but things seem to be loosening up just a little.  Your best bet these days is to get a referral from another investor who is already working with a particular bank.  This is another reason why local REIA’s can be a big help.  Plus you need to know your numbers and some “banker speak,” but that is a topic for another time.  If you can get a commercial loan, here are some key points to remember.

  • The interest rates are higher.  No more 3% rates.  Rates will be closer to 6 or 7% or more at the time of this writing.  So be sure to update your cash flow analysis.
  • Amortization will be shorter.  Gone are those 30 year amortization schedules.  15 and 20 year schedules are the norm.  This will increase the amount of interest and principal paid every month, so again adjust your cash flow analysis.
  • There will likely be a balloon payment or a call.  This means that the loan balance is due in a very short time, usually 3 to 5 years.  So while the payment schedule may be determined by a 20 year amortization rate, at the end of 5 years the balance is due and you will have to pay or refinance the loan.  You need to have a plan to deal with what one investor I know calls “this slow moving bullet.”

I wish we investors could get all the 30 year fixed rate loans we wanted.  But that is just not the case.  One option after you have exhausted the “traditional” source of financing is the commercial loan.  Commercial loans are a great tool for your investment business, just be aware of the terms going in.

Things to Know About Commercial Real Estate Appraisals

by Helpful Articles & Tips

BY DON DOMAN

“Commercial is very different from residential in the fact that appraisals are much more subjective in nature,” says Scott Everett, founder and president of Supreme Lending, a mortgage lender in Dallas. “Much of the value derived from a commercial building is based on the rental rates received relative to the expenses paid out. The underlying asset is important, but not even close to the same way that a residential properties value assets.” – www.inc.com/guides/201105/10-things-about-commercial-real-estate-appraisal.html

Much of the value derived from a commercial building is based on the rental rates received relative to the expenses paid out.

Most people think that inspecting a property is the main work of a commercial real estate appraiser, but no. It’s just the first step. Appraisals differ in difficulty, process, and length of time needed to complete the appraisal. Ownership, zoning records, and actual location need to be established. A land surveyor may need to be called in to check the actual description of the property as well as the condition and location. Demographics and lifestyle information may need to figure into the value equation. With Seattle and King County developing more and more businesses and workers, their housing and commuting need to be considered. Finally, existing commercial income and comparable property sales, replacement costs all need to be considered. Appraisers analyze all aspects that affect property values, before they begin to draw their conclusions and give an official and well documented appraisal. An appraisal may take weeks or months to complete because they need to stand up to review and anticipate change as well.

A land surveyor may need to be called in to check the actual description of the property as well as the condition and location.

One of the top things about commercial real estate appraisals is: “Appraisers Must Adhere to a Strict Code of Ethics.” Appraisers are easy to track. The have to keep up on local codes and national guidelines. Each appraiser is different, but here is an example of what people should look for in a Washington State appraiser: Richard E. Pinkley is the President and CEO of GPA Trueman, a Washington state corporation. Rick began his appraisal career in 1990 with Greer, Patterson and Associates, Inc. and purchased the company in 2002. In 2011 a purchase of Trueman Appraisal Company was arranged and the two companies merged with the operations conducted in University Place. Mr. Pinkley has worked for banks and mortgage lenders. He has been a leader of the local community of appraisers as the Treasurer of the Puget Sound Chapter of the Appraisal Institute and as branch chapter Chairman, serving as a voting member on the board of the Seattle Chapter of the Appraisal Institute. He is a candidate for MAI designation in the organization, and member of International Right of Way Association. Professional interests include problem solving for unique properties and complex projects. A particular specialty is the appraisal of Native American lands for tribal members, tribes and the US government. Rick has testified as an expert witness in Pierce and King counties. – www.gpavaluation.net/

Only after an appraisal is done can there be movement: selling, buying, financing, or construction.

In searching for a commercial real estate appraiser, look for a strong history of satisfied clients, familiarity with projects in particular counties and regions, and work on similar projects. Once you have selected an appraiser, then the process can begin. Only after an appraisal is done can there be movement: selling, buying, financing, or construction. With commercial property everything thing hinges on a legitimate commercial real estate appraisal.

 by the Sub Times

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Cash Flow is King- How a bank looks at your profitability and business equity.

by Self Published Articles

 

By Paul Long |  March 4, 2018

If you are looking for a business loan, making sure you have good credit and have reasonable time in business, then you are on the right track. However, understanding how a bank looks at your financials is another important part of the process. This article is going to show you how you can underwrite your own financial statements when seeking a new loan.

 

Cash Flow/ Debt Service Coverage:

Before we get into the analysis of the tax return lets evaluate a little about the business.

Paul’s Plumbing currently has the following debt:

Business Credit Card: $4,000 Balance with a monthly payment of: $150.00

Business Auto Loan: $50,000 Balance with a monthly payment of: $432.68

The client is looking for a $50,000 loan for a few new pieces of equipment. The estimated payment will be $966.64

The above tax return for an S-Corp will be used in this analysis example.

First we will look at the cash flow of the business and does the business have enough cash flow to afford his current payments as well as the new loan payment. This process is called finding a business’s Debt Service Coverage Ratio.

First we are going to look at Income/ Cash flow

Total Net Income (Line 21) : $22,111

Note that this number takes into consideration cost of goods sold, rent, salaries, and lunches at fancy restaurants that you “write off” etc.

Add Depreciation (Line 15): $4,500

Depreciation is not an official cash outlay, so it is added back to your net income.

Add the two together to get you cash flow per year to service debt payments of $26,611

 

The borrower has the following monthly payments:

Credit Card: $150.00

Business Auto Loan: $432.68

Total Monthly payments: $582.68

 

We are going to take the total monthly payment and multiply it by 12 (months in a year) = $6992.16

Based on the above analysis the business has $26,611 in annual cash flow and has $6992.16 in annual debt payments. Divide $26,611 by $6992.16 and you get = 3.805x. This number reflects that the borrower can service his current debt payments 3.805 times his cash flow.

 

Now we need to add in the new debt that he would like from the bank using the same exercise:

Credit Card: $150.00

Business Auto Loan: $432.68

Total Monthly payments: $582.68

New Bank Loan: $966.64

TOTAL monthly payments with new bank loan: $1,549.32

We are going to take the total monthly payments above and multiply it by 12 (months in a year) = $18,591.84

With the new bank loan based on the above analysis, the business has $26,611 in annual cash flow and would have $18,591.84 in annual debt payments. Divide $26,611 by $18,591.84 and you get = 1.43x. With this new debt the borrower will now be able to service their current debt and new debt 1.43 times.

Banks will look for 1.25 times or better to approve a loan based on cash flow. The above analysis shows that the borrower passes the cash flow test of underwriting.  Now play with your last tax return and use your debt to calculate your own Debt Service Coverage Ratio.

 

Business Equity/Balance Sheet

 

Another important part of the underwriting process is understanding your business balance sheet. Bankers will look at your current cash position, amount of existing debt and the amount of Equity in the company.

Banks need to make sure that the company has equity (It is the difference between what your business is worth (your assets) minus what you owe on it (your debts and liabilities).

Equity is one of the most common issues with smaller businesses due to the business owner taking out all the money out of the company for personal reasons. Banks want to make sure that the business has some skin in the game as well and that that not all of the risk is on the bank/lender. Having negative equity is common in startup businesses, but should get positive over time. In the case below Paul’s Plumbing has $21,950 in business value. The higher this number, the more the bank is willing to lend.

There is a lot more to the loan underwriting process, but coming to the bank with knowledge of these two processes will go a long way in your request.

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I want a Line of Credit for my business. Read me first!

by Self Published Articles

By Paul Long
October 15, 2017

Lines of Credit are great tools for small businesses!

Lines of credit are for businesses who want to borrow money on demand for short term purchases. Do you need funds quickly to purchase inventory or need some extra funds to make payroll, then use a line of credit. Lines of credit have more favorable repayment terms than term loans (payments based on interest only to 1-2% of the loan balance) as well as interest rates can sometimes be less than a loan. Best of all if you don’t owe anything on your line, then you don’t have a payment. The bottom line is they are very flexible.

What type of business SHOULD have a line of credit?
I do not recommend that all businesses have a line of credit. If you are a cash based business where your clients pays you upfront in full then a line of credit is not suggested. If you are a business where your clients pay you in 30-60 days after you provide a service or product then you should have a line of credit. Lines of credit (when used properly) are primarily used for short term purposes until your clients pay you for the service. I see time and time again cash based businesses receiving a line of credit and they use it for long term assets because they payments are cheap and never pay the line back. When this happens banks call this a “term out” which is when the bank chooses to turn off your line of credit, raise your interest rate and have you make large monthly payments until it is paid in full.

What banks use to collateralize a line of credit?
In fully transparency there are banks out there that offer lines of credit for your business with no collateral and just use your personal guarantee. These lines of credit have higher interest rates and annual fees because of the risk to the bank. You must have A+ credit, been in business over 2 years and have solid business income to receive one of these products.

Most banks will want some sort of collateral as well as to know to why you need the line of credit. Most Lines of Credit are secured with your businesses Accounts Receivables. For example, you may typically have $90,000 in accounts receivable owing in any given time from your clients who will pay you in the next 30 days. A bank will typically lend you 75-80% of your accounts receivable in the form of a line of credit ($72,000). Once your client pays you in 30 days you will pay that toward the line of credit that you advanced from to cover day to day costs when during those 30 days. This cycle continues over and over.

Definition: Accounts receivable is a legally enforceable claim for payment held by a business against its customer/clients for goods supplied and/or services rendered in execution of the customer’s order. These are generally in the form of invoices raised by a business and delivered to the customer for payment within an agreed time frame. Accounts receivable is shown in a balance sheet as an asset.

The same goes for Inventory based lines of credit. If you need to purchase inventory for your business you can advance up to 50% of the value of your inventory in the form of a Line of Credit. For example, if you have $75,000 in inventory usually you can borrow up to $37,500 from your line to purchase additional inventory. Once you sell the product then you will pay back your line of credit.

These examples are primary reasons for needing a line of credit, you may think of other reasons why you need a line of credit. Make sure you talk with your banker to make sure you are set up properly.

Resting Periods
Banks usually put a resting period on a line of credit, this is a time where the line of credit is not used. It may range from 10 days up to 30 days. The point of this is to make sure that you are using a line of credit properly which is use it, pay it off, use it, pay it off… Yes, the banks is enjoying the interest you are paying during this time, but at some point we want to principle to be paid back too. The rule you need to always have when you make an advance from a line of credit is will I pay this back in 60 days, if not then you may want to consider a term loan for your purchase.

It is important that you know some of these basics before you get a line of credit. This is a tool in your financial backpack you can use, make sure you use it correctly. You wouldn’t use a calculator to fix your car would you?

4 items you should never carry in your wallet

by Helpful Articles & Tips

by: Wendy Bignon

If so, take a minute to go through each and every item in that wallet. There are some things you should surely throw away, and there are others you should take out and file away immediately to prevent identity theft.

Social Security card

It may seem obvious to not carry this with you, but many people have long kept their SS card in their wallet. But think about it, if you have your number memorized, which most of us do, when do you actually need your card? Have you ever had to present your card to someone? Carrying this information around with you is a bad idea. If the wrong person gets ahold of your number you could end up with loans opened up in your name and new credit card accounts.

Passwords

It seems every website we visit now requires a password. How are we ever supposed to keep up with them all? It’s a great idea to have a cheat sheet where all your passwords are kept, but do not be tempted to keep this information in your wallet. Instead, keep your notes at your desk or filed away somewhere at home with other sensitive information.

Credit cards

Many of us are way past the point of having just a credit card for “emergencies” (last time I checked, few emergencies occur at Macy’s). It’s hard to check out at any retail store without being asked if we’d like to “save 10% by opening up a store credit card.” CB (CU “save 10% by opening up a store credit card.”) No matter how many cards you have, it’s wise not to carry all of them in your wallet at once. Think about it: if your wallet is stolen or lost, would you want someone to have access to every account you have? Instead, keep one card with you for those emergencies and leave the others at home in a safe place. This can also keep you from making spur of the moment purchases you’ll likely regret.

Receipts

Once you get home from a store after making a purchase, decide right then if you need to hold on to the receipt. Is there a chance you’re going to return the item? If not, then toss the receipt right away. If it is a larger purchase, you may want to keep the receipt until after the purchase shows on your next credit card statement, to ensure you were charged the correct amount.

 

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