Types of Mortgages and Strategic Solutions
A commercial property loan can be arranged for acquisition, construction, or debt refinancing of a commercially zoned real estate property, or it can be acquired to finance other commercial activities within the business entity that owns the property. Security for the financing is in the form of a registered mortgage in first, second, third, or further subordinated position.
There are basically three different categories of commercial property lenders. Within each category are sub categories to provide for the many specific types of commercial real estate that exist in the market place. Cash flow, credit, and collateral that is offered by a potential applicant or borrower will usually determine which category of lenders might be available to the borrower.
The “A” credit lender is made up of banks, pension funds and other similar institutions. Although each lender has different funding priorities, all “A” credit lenders have similar standards in terms of credit scores for the borrower and principals, cash flow, debt service coverage, and loan to value requirements. Funding is the most difficult to get from an “A” lender, however they are the primary target due to the rates that they provide. Rates can be 50% or less what other categories of lender would be.
While all properties owners would like to target “A” lenders for some or all of their financing, the reality is that there is a significant portion of the market that cannot qualify for this class of financing for some or all of their projects. Some geographies or industries will only see 50% or less of their commercial debt financing provided by “A” lenders.
If a property, project or business cannot qualify for an “A” caliber commercial mortgage, then the subprime commercial market is will be used. This market is basically divided into two different groups: subprime institutional lenders, and private mortgage lenders.
The subprime institutional lenders target commercial property loans over 1,000,000. Merchant banks, investment funds, hedge funds, and similar funders make up this category of lenders. These funders still have fairly strong cash flow, credit, and collateral requirements, but will fund deals the “A” lenders won’t. Because “A” lending criteria can be hard to qualify for at times, depending on the strength of the economy and overall global financial marketplace, a large portion of the funding that is done can fall into this subprime category. Sub prime institutional lenders are typically interested in providing financing for a one to three year period, allowing the borrower the time to strengthen their borrowing profile which will allow them to eventually refinance the debt with an “A” lender in the future.
The third category of lenders is the private lender. Private mortgage lenders look at any size of deal, however they typically fund deals under $3,000,000. Private lenders are mostly made up of individual investors but can also include syndicates, joint ventures among investors, and mortgage investment corporations. Private lenders charge the highest interest rates and can often have creative security requirements, which enable them to do deals that they might not otherwise. They are usually more concerned with the value of the equity in the property and the resale value and potential than other credit terms.
A commercial mortgage from a private funder can vary greatly in rate, fees and other aspects. Other types of lenders have narrower sets of requirements so their rates fluctuate much less. The biggest factor influencing all funders though is the perceived risk of return due to defaulting or resale challenges. Most private mortgages are also for shorter terms (often one year or less) and therefore provide very short term bridge financing to the business or property owner.
Commercial mortgage funders have different criteria, different lending appetites at different times, have different risk profiles, and provide different terms to a borrower. Because of the differences between properties, industries, geographies, etc, it can be difficult to locate and secure a funding suitable to your specific needs.
Customers often come to us with projects that they couldn’t get funded by a certain class and we are able to arrange financing from a lenders in that class. Without the experience and knowledge of the lenders it is difficult get suitable funding terms. Let Sumex Capital help you find “More Ways to Yes”
A bridge loan of any type is a short term loan where there is a specific amount of money required for a specific period of time. The ability to repay the loan must be well established and can come from another longer term mortgage, another type of financing or equity injection, or the sale of the property. Bridge loans can be unsecured, however these are more difficult to get and usually rely on equity or cash flow from other business or personal interests. Financing that is for less than two years is often considered a bridge loan. Due to the increased level of risk in a bridge loans they are provided at higher rates.
Real estate security backed bridge mortgages are one of the most popular forms of short term borrowing for a number of reasons.
Capital generated from a real estate bridge loan does not typically have to be used to acquire or improve property allowing equity in real estate to be utilized for a wide variety of other purposes.
Loan underwriting is very straight forward as the focus is more on the loan security versus the use of funds. Bridge lenders can often use existing appraisals and environmental reports which speeds up the funding process and also keeps the costs down.
Bridge loans can be completed quickly (10 to 15 business days).
Bridge funding is often used when a deal may not be able to get done fast enough to meet a deadline. This is common when trying to close on a property purchase, refinance an existing mortgage, provide a cash flow injection to fund a growth opportunity or meet some other deadline.
Lenders that provide bridge funding know that their competitive advantage is speed over cost. These funders know that they must move quickly or they will not be successful with the funding. They have people and processes in place that support this type of lending.
Bridge loans are consider sub-prime or private mortgage solutions, so the cost of financing is often much higher than term mortgage rates from banks. It is important to consider though the return on investment, the value you are trying to retain, or other costs you are trying to avoid when making a decision on whether or not to consider this type of funding solution.
Bridge financing can be done as 1st, 2nd, or even 3rd mortgages, provided there is enough equity in the property to cover the incremental capital being advanced. In order to bridge financing quickly, a property owner will need to have all of the necessary documentation in order including old appraisals, property tax assessments, title searches, and other ownership and lien related information. Bridge loans under $2,000,000 are more readily available. However, as there are a limited number of bridge funding sources, it is critical that you are aware of their criteria and capabilities so you don’t compromise your project timeline.
Bridging amounts above $2,000,000 typically take more time to secure as more lender due diligence typically accompanies this larger deal size.
The exit strategy and fall-back position are two key factors in the decision making process for the lender. A secure refinancing or sale, a low loan-to-value, and a vibrant market allow a borrower to quickly secure a bridge loan and also get the best possible rates from the lender.
Lenders will often consider charging interest only payments on a monthly basis during the term of a bridge loan. Depending on the lender, they may allow interest to be prepaid from the mortgage proceeds if cash flow is not available to service the loan. Terms can sometimes be extended, however there are typically incremental lender fees for the extension. Prepayment options are lender specific and range from fully open to fully closed with the middle ground of being fully or partially open after a certain number of months.
Sub prime and private mortgage lenders tend to work through broker channels for their deal flow and rarely have their own retail presence to deal directly with commercial property owners.
A private mortgage on commercial real estate can be a very important financing option to consider for a business or property owner. The ability to quickly access equity held in real estate can be and important source of financing. Any type of private funding is going to be short term in nature. The use of this type of commercial mortgage financing is often driven by amount of capital required or the time you have to work with. There can be other considerations such as refinancing the existing first mortgage or securing a business loan against cash flow and other commercial assets. And while some of these other options may be put into place at a lower cost, the issue around the time it will take to get money into place is typically a deciding factor.
In some instances a business or commercial property owner has recently experienced a drop in earnings and is seeking additional capital from their commercial real estate. Even if they have time to get a new bank or institutional first mortgage in place, they may not be able to qualify for one. Leaving a good rate in place on a first mortgage and getting a private second mortgage for a smaller amount can result in the weighted average cost of capital being lower than a new first mortgage at sub prime or secondary banking rates.
The application requirements of a bank or institutional lender for any type of commercial mortgage are going to basically be the same, regardless of the amount of financing required or if the mortgage is in first or second position. This will include a new commercial appraisal, new environmental assessments, interim financial statements, etc. These costs, when amortized over shorter term drive up the effective cost of financing. The resulting rate can be well above what you might be paying with a private 2nd.
Another great advantage of most private lending is that your use of funds can be pretty broad. Some use this type of funding for equity take-outs. A bank would typically require borrowed funds to be invested back into the property, or at the very least back into the business that owns the property. Smaller requested capital amounts, which are common with second mortgages, will also tend to draw less utilization questions than larger requests.
So if you require some capital and you have equity in a commercial property that you can leverage, a private second mortgage on commercial real estate is an option worth considering.
Commercial construction loans and/or commercial development loans required for construction and development projects can be provided through conventional lenders such as banks and other primary financial institutions. They can also be obtained from sub prime and private mortgage lenders. Banks or institutional lender have the best rates. However if your project does not conform to the risk profile of a bank then a sub prime market will need be considered.
Some of the biggest differences between banks and subprime lenders or private funders are:
- the security position of the lender;
- the time to complete the application and funding process; and
- the draw management requirements.
In almost all cases, a conventional lender will not provide a construction mortgage in a second mortgage position behind an existing debt registered against a property. The new financing will need to consolidate the existing debt into a new loan and provide the construction or development financing, or the property owner will have to pay out the first mortgage before the financing can be secured. Many of the construction financing deals are done through sub prime lenders.
The application process can often be long with a conventional lender. And in order to justify the low rate that a bank will charge, there are usually more conditions that a borrower needs to meet. This usually slows down the approval process. The length of time that a funder takes is often directly correlated with the size of the organization. The bigger the lender is, the more people and levels that typically must review an application. And many of the banks require the approvals come from cities other than where the funding application is being made. In Canada this is often Toronto or Vancouver that the approvals will come from.
If you start early and allow lots of time to get a loan in place you will have a greater possibility of getting lower financing rates. Construction and development financing tends to be requested at different project stages and often there isn’t considerable lead time.
Non bank construction loan alternatives typically are provided through more specialized and smaller lenders that can act quickly. Sub prime and private lenders also tend to more flexibility in their underwriting process. This is offset by a slightly higher cost of capital, though.
Most builders and developers have experience with draw management requirements and procedures as these payments are critical to their operations. Bank and institutional construction draw requirements are typically far more rigorous and rigid than alternative financing options as well. Banks may require builders or developers to have reserve cash and/or credit to draw from in order to deal with potential draw advance delays or cost overruns. The key differences between institutional and non institutional construction lenders involve timing and complexity primarily.
Construction draws typically require work to be completed to a certain level before funding can be made available. And if there are cost overrun or changes in scope that add cost to the overall project, the primary lender may require the borrower to inject the additional funds before the lender will allow further draws to be made.
Alternative lender construction loans are sometimes used to provide the capital shortfall with lender security falling behind the senior lender on the project. Once again, these types of financing requests are not planned in advance, so speed in getting funds in place is also going to be important in addition to the amount of money required.
While minimizing the cost of financing is important, capital availability, and time all need to be assessed when choosing a source of capital for a construction project.
Many projects look to non bank options as the primary or senior lender for the overall project, as a bridge or short term lender to meet unplanned shortfalls, or as a stage lender to cover off one complete stage of the development such as site and servicing work before vertical construction begins.