This article describes 12 recurring problems with commercial real estate loans that commercial borrowers and their advisors need to anticipate before it is too late. The following problems are common in traditional bank commercial real estate loans and should be avoided if feasible (special circumstances will periodically make some of these terms unavoidable).
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 1: Tax Returns versus Stated Income
Most traditional banks will require several years of tax returns in order to qualify for a commercial real estate loan. The alternative is to use a Stated Income lender that does not verify personal income or assets. Many borrowers will simply not qualify for a commercial mortgage loan if tax returns are used due to high business expenses (and low net income). Many lenders using tax returns will also continue to verify income after the loan closes. Stated Income lenders will not engage in this practice.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 2: Special Purpose Properties
It is becoming increasingly difficult to get commercial loans for special purpose properties. Properties that do not fall in the categories of apartments or retail/office buildings are often placed in this special purpose classification. This means that business acquisition loans for commercial properties such as restaurants/bars and auto service businesses are frequently hard to find. Commercial financing will be even more difficult to locate for such specialized properties as churches, funeral homes, nursing homes and assisted living facilities.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 3: Recall/balloon features
These terms are used by many banks to effectively shorten most commercial real estate loans to 3-7 years.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 4: Short-term loans (less than fifteen years)
15-40 year commercial property loans without recall/balloon features are available.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 5: Up-front Commitment fees
Under most circumstances, commercial borrowers should not pay such a fee. Please note that processing/retainer fees are not included in this discussion of commitment fees. Processing/retainer fees should be viewed as an acceptable and standard business practice when dealing with commercial real estate loans.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 6: Business Plans
Under most circumstances, commercial borrowers should not use a lender that requires a business plan.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 7: Cross-collateralization
Commercial borrowers should not be required to use their personal assets as collateral for a commercial property loan.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 8: Sourcing and seasoning assets. Seasoning of ownership.
This particular problem will not be relevant to all business borrowers. However, if it is relevant, you should seek out a lender without sourcing and seasoning requirements or limitations. Most banks have strict guidelines for sourcing and seasoning of assets or ownership to qualify for commercial real estate loans. For a purchase, commercial lenders will frequently want documentation about where the down payment is coming from (sourcing). Commercial lenders will also frequently have very specific requirements stipulating that the funds must have been in a specific account for a specific period of time, often 3-6 months or longer (seasoning). Seasoning of ownership is similar to seasoning of funds, except this requirement involves the minimum time someone has owned a commercial property before they can refinance the property.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 9: Requirement to sign IRS Form 4506
IRS Form 4506 authorizes the lender to obtain a borrower’s tax returns directly from the IRS. This form is routinely required by most traditional banks and many other commercial lenders for a business acquisition loan. Commercial borrowers using a Stated Income lender with limited documentation requirements will avoid this requirement.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 10: Debt Service Coverage Ratio (DSCR) in excess of 1.2 for a business acquisition loan
The most flexible approach to DSCR for a commercial property loan will require a DSCR in the range of 1 to 1.2, with exceptions permitting a DSCR less than 1.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 11: Minimum commercial property loan size that is too high for your commercial mortgage needs.
It is not unusual to encounter a minimum commercial real estate loan requirement of $500,000 to $1,000,000.
COMMERCIAL REAL ESTATE LOANS PROBLEM NUMBER 12: Excessive length of the commercial real estate loan process
Many traditional banks require three to nine months to close a commercial mortgage. A more action-oriented commercial lender will close commercial real estate loans in 45 to 60 days.