I’m surprised how often I am asked to find financing for a property that for one reason or another is obviously not financeable. It’s as if the borrower wants the lender to forgo the use of common sense. I’m going to let you in on a little secret: IT ISN’T GOING TO HAPPEN!!! Anyone who is at all knowledgeable about commercial real estate lending realizes that lenders are risk averse. They are not in business to take on any more risk than is absolutely necessary.
So if you want to either refinance your property or to sell your property there things you must do a year or two before financing is needed to get the property to the point where I call it, “lender friendly.” Not doing so will likely make it much more difficult, if not impossible, in getting a lender interested. Here are four common mistakes:
1. The property is in poor physical condition. It’s a big turn off to lenders to see a property poorly maintained. Why would a lender refinance a property for a borrower that is not willing to maintain his property? If you want to refinance a property that has a lot of deferred maintenance you better have an excellent explanation as to why it’s in poor condition. Better yet would be to get the big ticket items fixed prior to refinancing your property.
2. The occupancy rate for the property is below market calling into question the seller’s property management company’s ability to professionally manage the property. If the property is self-managed you’re in deep trouble. If the property is for sale some sellers or listing brokers think that providing a rent guarantee on the unoccupied space will satisfy a lender’s concern. WRONG!! It does just the opposite. It’s a great big red flag that something is wrong with the property. A better solution is to offer as much free rent as needed to get the vacant space occupied. Offer the free rent at the beginning of the lease. Once the free rent has burned off, then refinance or put the property up for sale. You still need to disclose the free rent to the lender but it is much better to have your property at stabilized occupancy with free rent than to have a property with a high vacancy rate.
3. Operating expenses are well above normal for a property of that age and condition. You need to investigate if there is a reason for this. Is it an anomaly? Are some ongoing maintenance expenses actually capital expenditures? Can you explain why? If you can determine that the additional expenses are costly one-time expenses then capitalize what you can identify and operate the property for a year to show what your operating expenses should be for a normal year. If you rush to refinance the property with higher than normal operating expenses it will likely lower the loan amount because of the lender’s minimum debt coverage requirement. And if you’re trying to sell the property, the value of the property will be adversely impacted because the NOI for the property will be lower than it should be. Worst case scenario, the lower NOI could reduce the loan amount and thereby increase the equity required by the buyer beyond what he is willing to invest in the property killing your sale.
4. Most tenants are on a month-to-month basis (not a concern for apartment renters) or have only 1 or 2 years remaining on the term of their lease. Most lenders will not accept rollover risk. Again, proposing a rent guarantee on those tenants whose leases have expired or will expire shortly is a big turn off to lenders. One way to mitigate risk is to identify when each tenant originally moved in. If they have been a tenant at the property for 10 or more years then it is much less likely they plan to move once the lease expires. But the best thing to do before you sell or refinance your property is to get as many tenants re-leased for as long as possible. Once you’ve minimized the rollover risk then seek financing.
Remember, it’s all about getting the lender as comfortable as possible with financing the property. You’re asking the lender to lend you or your buyer lots of money. Make sure to take some common sense steps prior to requesting a loan that makes it easy for the lender to say yes.