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Running Your Business:
How a Lender Sees Your Commercial Building
By Christopher Perez

What is the difference between restaurant owners who own their building and those who rent? The ones who own their building have two sources of wealth generation: their business and their commercial real estate property.

The simple economics of land ownership - finite supply and increasing demand - often means the commercial real estate holdings have a significant positive impact on the ultimate return of the business.

But it's not just cashing out where real estate can make a difference. The combination of declining loan balances and (hopefully) advancing property values means that entrepreneurs can build equity. This equity represents a valuable resource in their small business tool kit. Unlike their competitors without real estate holdings, they can borrow against the equity in their property to fund new initiatives, expansion and the acquisition of additional properties or businesses. And they can do this without diluting the ownership in their own company.

But this flexibility comes with a price. Lenders who lend against real estate must protect themselves against the risk that the loan - despite the best intentions and efforts of the principals - may run into trouble and not pay off through cash flow from the business, but rather through the outright sale of the property. What this means is that while you may have $300,000 of equity in a property, lenders cannot lend against the full value of the equity. In fact, they can only lend against a portion of the equity.

Because the lender must take into account a worse case scenario - either because they are a fiduciary lending funds from another investor, or because they must preserve their own capital against loss - the question becomes, how does a real estate lender view your commercial building?

Knowing the lender's perspective in property valuation will help you understand some of the thinking behind your lender's terms, and perhaps provides some purchase points for negotiation on the loan-to-value ratio (LTV). This LTV represents the amount of equity you can borrow against, and as such is the single most important determinant of the funds that you can access through the equity in your commercial property.

Elements of Comparison
Typically, commercial lenders that use real estate as collateral look at comparable sales, and adjust their findings with so called elements of comparison and an assessment of the property's marketability.

First, let's look at comparable sales and elements of comparison. Just like any buyer, the lender will look at sales of comparable properties in the surrounding area. Then the question becomes, does the would-be borrower's property seem to be worth more or less?

You've heard the old real estate saw: Location, Location, Location. When lenders look at a commercial building as collateral, this is perhaps their first consideration. There are elements of location that add value and there are elements that subtract value.

A central business district location is better than one in a remote area. A corner location is often more desirable because it generally gets twice the traffic than a locale adjacent to two other buildings. A building on a one way street will see less traffic than one that is not. At the same time, a building that has no street frontage would be viewed by a real estate lender as less valuable than one that did.

Another important element of comparison is land area in relation to the building and the enterprise. For instance, a building that covers most of it's land area with little or no parking would not compare as favorably to a building that had more parking, or a loading dock, or room to expand the building. While some business would not need these amenities - such as a small manufacturer, or a repair shop - in the lender's eye, diminished land area limits the number of would be buyers in a liquidation scenario, and as a result, reduces value.

A third important element of comparison is the overall size of the building. Again, this is a relative comparison to the property type. If your building houses your auto repair shop with three bays, while most other independent repair shops have between four and six bays, your property would be considered small, which would have an impact on its value in the eyes of the lender. By the same token, buildings that are large by comparison pose challenges too. A building used for dry cleaning that is three times the size of a typical dry cleaner would be viewed by a lender as less desirable than one that was typically-sized.

Marketability
The elements of comparison hold little intrinsic value. Their real meaning comes from how they influence the marketability of a property.

Remember, if a lender ends up as the owner of a building, it's not by choice, but literally by default. This means the lender will seek to sell the building in a reasonable period of time. While many lenders want to avoid the losses that can come with a very quick sale, they do not want to own a building over a prolonged period of time, where taxes, maintenance, and unforeseen events can have a material impact on their ability to recover the principal balance of the loan. Generally speaking the maximum time period which a lender will want to own a building is between six and 12 months.

The correlation between marketability and the loan to value ratios runs inversely. That is the longer it appears it will take to sell a building, the smaller the amount the lender will advance against a building owner's equity. Thus, the commercial lender's focus on elements of comparison and marketability are closely intertwined. Specifically, buildings with unfavorable elements of comparison take the longest to sell, and as a result pose more risk for the lender. The lender mitigates this risk with a lower loan to value ratio.

Who Loves Ya?
For borrowers that have single purpose commercial properties, the lenders' approaches toward property valuation can prove frustrating. From a lender's point of view, the dedicated purpose of the building does not add value, but rather shrinks it, because there is a smaller pool of buyers which, which in turn increases the time that may be required to market the property. Some lenders will not even consider such a property as collateral.

Restaurant owners seeking loans backed by owner-occupied commercial real estate may find non bank lenders more willing to strike a deal, or seek creative solutions to get a deal done. There are two reasons for this.

First, traditional lenders have dramatically increased minimum loan amounts. Many want to make loans no less than $1 million. This is a difficult proposition for a business owner with $300,000 to $400,000 in equity looking for a $250,000 loan. Second, most bank lenders avoid loans where the underlying property to be used as collateral has a single use, or which may have one or two unfavorable points of comparison. The rigidity of their underwriting process and the size of their existing franchise often precludes them from taking risks they don't have to. Rightly or not, their attitude is often something akin to, 'Why should we?'

Non bank lenders, by comparison are more niche oriented. Whereas banks see the market for small businesses loans of less than $1 million as, well, small, and rife with irregularities, non bank lenders may see more opportunity. Accordingly, they are more willing to consider unique properties and willing take more time to structure a deal which fits the needs of the borrower, yet still mitigates their risk.


Christopher Perez is the Director Commercial Lending for Nassau Mortgage Company in Newtown, PA. As a former bar and restaurant owner, he understands and appreciates the problems facing the restaurant industry when it comes to financing. You may contact Chris directly at cperez@restaurantreport.com or by phone @ 1-800-481-5101




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