How to Get the Best Rate

The interest rate, terms, conditions and closing costs for a commercial mortgage loan are highly predictable, and will be based on two factors: the type of lender (conduit, portfolio or non-bank lender) and the property's attributes (operating performance, conditions and characteristics, and market).  The borrower's credit worthiness or personal income is not one of the primary factors. 

Type of Lender

The first time a mortgage broker works on a commercial mortgage loan, he is inclined to search for a lender, rather than analyzing the property's attributes to first determine which type of lender is most suited for the loan based on the property's financing risk.  For example, conduit lenders fund loans to be securitized and typically offer the best rates for those properties that reflect the least amount of risk.  The fees for conduit lenders are set and typically do not vary from conduit to conduit.  Portfolio lenders are credit companies, banks, S&Ls, insurance companies, and even Fannie Mae/DUS and FHA lenders.  These lenders also can offer competitive interest rates and terms, equivalent to a B-piece conduit deal.  Fees may be similar to conduit fees, but may also vary from lender to lender.  Non-bank lenders are stated-income/stated-asset lenders, low doc/no doc lenders, private money and hard money lenders, which typically look for non-bankable deals that pose higher risk, and therefore, the interest rates tend to be much higher, with more restrictive terms and conditions, as well as higher fees be charged to compensate for the higher risk. 

Again, the type of lender you ultimately need for your loan is highly dependent upon the financing risk associated with the property, which can be determined by analyzing the property's attributes, described next. 

Property Attributes

As it relates to the property, the three primary issues that affect the interest rate, terms, conditions and closing costs, as well as the type of lender, are primarily the following:

• Operating Performance of the Property

• Property Conditions and Characteristics

• Market Attributes

Operating Performance relates to the property's cash flow and tenants.  Cash flow on commercial properties are analyzed over a three year period mainly because income changes from year to year due to changes in occupancy (gross rents) and operating expenses of the property.  It is important to note that the loan is based on the present value of the property's cash flows, not future value or upside potential.  Upside potential is a factor considered by the property owner, but is not addressed in the property's underwriting. 

The following is indicative of a commercial property with strong operating performance:

• The property will show strong operating performance with no material declines in revenue and net operating income over the past three years.

• The property’s occupancy will be at or above the local market’s average occupancy with no material declines over the past two years; however, newly constructed or recently rehabilitated properties which have not reached stabilized occupancy will be considered on a case by case basis.

• The tenant base will be diverse and creditworthy.

• Borrower and property manager should have significant experience in owning and managing, respectively, several properties similar to the mortgaged property and situated in comparable markets.

For example, if building A had ten tenants, all credit-rated with an average lease term of three years, and building A had ten tenants, with no credit-rated tenants and lease terms of one year, the operating performance of building A would appear to have lower financing risk than building B.  Here is a good time to talk about underwriting reserves as they relate to operating performance.  Both building A and building B will have expenses associated with tenant improvements for renewing tenants and new tenants, as well as leasing commissions for renewing tenants and new tenants.  Lenders will apply what is called an underwriting reserve to the operating statement, which will appear as an expense item, to determine if the property can afford to renew tenants and attract new tenants.  The TI/LC reserve is usually reflected as a cost per square foot, and only applies to property's which have tenants, or could have tenants, such as in owner occupied buildings.  Other such reserves associated with operating performance is the management fee, which is applied regardless of whether the property is managed by the borrower or not, and vacancy reserve, which assesses the historical vacancy, the market vacancy as well as the current vacancy.  Even if the property is currently 100 percent occupied, a vacancy reserve will be applied to reflect potential vacancy and collection loss.

Property Conditions and Characteristics relates to conditions such as the age of the building and the when it had last been refurbished, as well as characteristics such as anchored retail versus unanchored retail, or flagged hotels versus hotels without a flag. 

The following is indicative of a commercial property in good condition with attractive characteristics:

• Post 1980 construction is preferred.

• Older properties in good repair and having undergone material renovations within the last ten years.

• Remaining useful life of the property, with the shorter conclusion of either the Appraisal or Engineering Report will extend at least seven years beyond the end of the amortization period.

• Building design, floor plan, technological capabilities and amenities will be appropriate for the immediate market area.

• No material required repairs or deferred maintenance, unless satisfactory reserves are established.

For example, if building A was built in 1950, but had no deferred maintenance items and was refurbished within the last five years, and building B was built in 1990, but had deferred maintenance items and was never refurbished, building A would appear to have lower financing risk.  Underwriting reserves also relate to property conditions and characteristics.  Replacement Reserves is another type of reserve that a lender will apply to the operating statement as an expense item to determine if the property can afford to maintain the building, and pay for any major replacements, such as HVAC.  The Replacement Reserve is usually reflected as a cost per square foot, unless it is for apartments or other property types, where the replacement reserve is reflected as a cost per unit.  A Cap Ex Reserve or capital expenditure may also be applied to reflect one-time, big ticket purchases, such as replacing the entire roof on a building.  However, if the roof just needed repair, it would be reflected as a replacement reserve.

Market Attributes relates to the market for which the property is located, as well as certain features of the market that are inducive to the property's operating performance. 

The following is indicative of a commercial property in with favorable market attributes:

• Established or emerging market with a minimum population of 50,000 is preferred with no quantifiable population declines since 1980 based on US Census data.

• Diverse employment and/or economic base.

• In fill locations that are reasonably insulated from the threat of new supply are preferred.

• Property must be located near, and easily accessible to major highways/freeways, employment sources and other demand generators. 

For example, office buildings should be located in a central business district while multifamily apartments should be located near schools and retail centers.  While there is no specific examples for underwriting reserves related to market, market issues do affect all of the reserves.  For example, the dollar amount used for the TI/LC Reserve is reflective of building costs and leasing agency costs in the particular market. 

How do You Determine the Right Lender and the Right Rate?

You have just been given a road map for analyzing commercial real estate.  A mortgage broker is expected to prepare a loan request that reflects each of these three property attributes, and then deliver the loan request to the right type of lender based on the financing risk you determined from your analysis of the property.  Remember, you are building a relationship with the lender and if you deliver a loan request that does not reflect the key property attributes that enable the lender to prepare a loan quote, then it is likely that you will never hear back from the lender.  And if you want the lender to price your loan aggressively, and give you the lowest possible interest rate, the lowest fees and the most favorable terms and conditions, then you must provide the lender with sufficient property data for which to base their loan quote.