A lender’s tip for financing a commercial real estate purchase - by Will Hatt

Will Hatt, Business Lending Solutions

For many businesses, purchasing a commercial property is an important step toward expansion and long-term growth. New property adds capacity to meet demand, establishes a physical presence, and, especially for startup ventures, communicates progress. For some, purchasing property for commercial leasing is a business venture itself. Whether you’re just starting out or looking to expand further, knowing what lenders are looking for will help you successfully navigate the commercial lending process. 

First, commercial real estate transactions function differently than traditional asset purchases. Lenders want to see surety not only in you as a borrower, but also—more importantly—in your business model. Your plans for the property directly impact your ability to fulfill your debt obligations over the life of the loan. With the demand for prime commercial real estate outstripping the supply in Maine and other parts of New England, lenders can afford to be choosy about the projects they finance.

So, what makes a solid investment? In short, clarity, competence and value. When applying for financing, demonstrable knowledge and transparency are critical to showing that you believe in the viability of your venture.

The following are some areas to focus on when seeking to finance a commercial real estate purchase:

Develop a clear business plan - Lenders and investors want to see a well-considered project guided by a clear business plan that articulates objectives and potential contingencies. Invest your time and effort into explaining your values and be prepared to discuss them in detail.

For example, most lenders will want to see details on the short- and long-term factors impacting your cash flow, including current leases and potential cash flow increases in the next 12-24 months. Especially if you plan to lease a property, research historical vacancy rates in the area and have a documented plan for how you will attract and retain tenants.

Debt Service Coverage Ratios (DSCRs) are also important to keep in mind. Lenders like to see DSCRs of 1.25x to ensure you have cash available for debt service and will likely test for various vacancy rates in the area to ensure the future revenue is tenable. Develop a contingency plan for how you will cover the debt service if the values don’t work at lower levels.

Know the value - Calculate the cost per square foot of your property to compare to other projects listed for sale. Research the city’s assessed property value and the historical tax bills. Also, talk to a reputable realtor to see if the asking price is reasonable; if your project is higher or lower than the average in the area, determine why and be able to communicate that to your lender.

Property condition - Your business plan isn’t the only thing you will need to prove. The state of the property itself will have a major impact on the lender’s decision to finance. If your property has significant deferred maintenance, you’ll need to provide a detailed plan and cost estimate on what it will take to bring it back to 100%. If you plan on performing the work yourself, cost estimates and a detailed timeline are especially important to show the lender your plan for implementing the upgrades. These will also need to be documented by a reputable and independent inspector prior to the appraisal and closing of your loan.

You, the buyer - While cash flow, value and property condition are important factors, lenders need evidence of your ability not only to manage debt, but to manage a commercial property as well. Have at least 3 years of tax returns at the ready, accompanied by a personal financial statement showing your current situation. You should also provide an up-to-date résumé documenting your history of business management experience.

For larger and more complex deals, personal credit scores tend to carry less weight in the credit decision but are nonetheless important. Lenders like to see that the guarantor or borrower has enough liquid assets to fulfill their debt obligation (that is, debt service) in the event of unforeseen challenges. A reserve of 3 to 6 months’ worth of debt service is a good start.

Skin in the game - Be prepared to put down at least 25% of the purchase price into the property in some form. This does not necessarily need to be all cash; combinations of equity and cash may also be acceptable. If approved, most lenders will offer terms for commercial real estate at 10- 15 years, though some may go as long as 20 years.

Ultimately, the better you can demonstrate a thoughtful plan for a commercial property, the more confident a lender will be in choosing to finance your purchase. Thorough research, planning and focus on the above areas will set you up for success – both in securing financing for your property and in the long run of your new enterprise.

Will Hatt is senior vice president and chief operating officer at CUSO Business Lending Solutions, Hampden, ME.