Swimming Upstream: How to Reposition an Unsuccessful Loan Request

Many borrowers today who are shopping for commercial real estate loans are getting a reality check. Some are facing maturity deadlines on existing loans. But these borrowers are discovering that the financing climate has changed since they last took out commercial financing.

Lenders have tightened LTV limits over the past several months in response to economic risk factors. At the same time, interest rates have edged upwards. That leaves some borrowers in a bind, caught between maturing loans and higher replacement costs.

Borrowers and brokers shop out these loan requests to multiple lenders, only to have the door close over — and over again. Unpacking the most common problem can shed insight on why these loan requests are unsuccessful, and what borrowers can do to meet their financing needs.

Valuation is Key in Commercial Real Estate Financing

When a loan request is continually declined, oftentimes it is not the borrower who is at fault. In fact, the borrower could be highly qualified, but the property is not.

Overestimating property value is a common mistake that leads to a failed loan request. And that’s not because the borrower is inflating value, but rather because the lender has parameters around how fast a property can appreciate.

Take for example a recent purchase of a building for $1MM. The borrower puts in another $250,000.  Six months later, online analytics place the property value at $2MM. The borrower naturally wants to cash out the windfall.

The lender is not going to see it that way. Even if the property appraises for the $2MM — which is unlikely — the lender will emphasize the purchase price and cash outlay. Here, that would place the value around $1.25MM.  With that value combined with a lower LTV, the borrower may be in position to pay off a maturing loan, but not cash-out.

Another example is the borrower who purchases the property and then puts cash into the business operations, like equipment or inventory.  Unless the receipts are for real estate improvements, the cash outlay here will have no impact on property value. The same is true if the borrower purchases a property and puts no additional money into it. Bottom line: recent purchases are hobbled by the purchase price.

That reality is especially frustrating for a borrower who purchased a property at a perceived discount over fair market value. From the lender’s perspective, however, the purchase price is fair market value.  That sets the basis for future appraisals.

There are other factors that lenders will scrutinize when assigning property value and determining LTV. For example, population density will impact the ability to measure value based on local comparable properties. In rural areas where comps might not exist, lenders may pass altogether.

Repositioning Your Commercial Loan Request

Borrowers or brokers who continue to cling to the high valuation are free to shop out the loan to multiple lenders. But chances are they’ll get the same response each time.

There are some workarounds that borrowers can consider to reposition a failing loan request. To do so, the borrower needs to:

  • Get their expectations in check. The financing environment changes, and borrowers may need to adapt.
  • Listen to what previous lenders have said when they decline. Modify the loan request to meet those objections.

One possible strategy to overcome a decline is to offer cross-collateralization. The borrower may have equity in another commercial property that could serve to bolster the loan request.

Of course, the borrower can come in with more cash down to secure the loan. Bringing in equity partners is another solution that works well especially with construction loans.

Bridge financing can provide more flexibility with qualifications and may overcome lower property valuations.  A bridge can be a viable solution for many borrowers who can continue to increase income while they wait for perm loan rates to go down.  BEP now offers a short-money program, a hybrid non-recourse, interest-only loan with a 5-year term.

Finally, a borrower may simply want to hold off and allow the property to season. If the borrower is not facing maturity default, they may benefit from holding the property and continuing to evolve the income. The more distance the borrower can put between the purchase date and a new appraisal, the more options the borrower may have for refinancing.

Boulder Equity Partners LLC is a nationwide lender for commercial real estate, offering a wide range of loan programs including perm, construction, short-term rental, short-money, and bridge loans that can be migrated into perm.