As I continue to hunt for a (bigger) apartment building deal, I am interviewing lenders and brokers to better understand their underwriting requirements.
This is critical if I want to successfully close deals I get under contract.
In this article I will share with you the most common underwriting requirements and terms you can expect from a commercial lender, and also how you can satisfy their lending requirements even if you don’t qualify yourself.
Imagine a scenario where you did everything right: You found a good deal and put it under contract, maybe you raised some money from investors, you did the due diligence and are still happy with the deal.
Now, you start the loan process. Your lender requests your personal financial statement but then tells you don’t have the net worth and liquidity to get financing.
Suddenly you realize you’re in trouble. While you pride yourself in the nest egg you’ve built up over the years, you also know that you don’t have the net worth to match the loan amount, and you certainly don’t have 9 months worth of liquidity in reserves.
Wouldn’t it have made sense to ask your lenders about their lending requirements before hand?
As I sat down with each loan broker/lender the last few weeks, I gave each one multiple scenarios and asked what they are likely to require to approve the loan and what the terms would be. What would the terms look like for a stabilized asset? What about one that is not? What would a bridge loan look like?
The answer will vary, of course, depending on the situation, deal size, and the lender you speak with. You won’t get any guarantees, but you will see patterns emerge that you can use as you put together the financing.
Here are some rules of thumb:
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Debt Coverage Ratio
This is the ratio of your debt service payment to the net operating income. For a stable asset, the lender will look for at least 1.25 ratio. For a riskier project, the ratio may be higher. For more on Debt Coverage Ration, See Debt Service Coverage Ratio (DSC) – What it is and Why it Matters For You
Loan to Value
This is the ratio of the loan balance to the value of the asset. For a stabilized asset in good areas, banks will lend up to 80% of the value. I use 75% in my projections and even lower if the property is not stabilized.
Lenders are looking for a net worth of the sponsor (or sponsors) that equal the loan amount. If your personal net worth does not meet these requirements, partner with someone who’s willing to sign the note with you. Offer that partner some additional equity in the deal, or pay him a fee at closing.
Lenders like to see liquidity equivalent to 6 to 9 months of debt service payments. They typically don’t require you to keep this in a separate account, they just want to see that level of liquidity in the sponsors’ personal financial statement. If you have a partner signing the note with you, then the bank will also consider that person’s liquidity.
Banks like personal guarantees. Loans that need to be personally guaranteed are also called “recourse”. This means that if you were to default, the bank could go after your personal assets.
You want to avoid personal guarantees in general, not only for yourself, but also for any investors you have involved in the deal. Your investors are typically “limited partners” with limited decision-making authority, and they’re not investing with you to take on any more liability than potentially losing their principal.
For loan amounts under $1M, the banks generally will want a personal guarantee. Interestingly, the higher the loan amount, the more likely you will get a non-recourse loan (another reason to try to go BIG as soon as possible!).
You can negotiate personal guarantees (and other terms of the note). For example, you might be able to “bleed off” the guarantee, which means that the amount of the guarantee decreases over the years.
Bridge loans normally require a personal guarantee but then can go away once the asset has been stabilized.
To me as a syndicator, I am mostly concerned about the recourse, net worth and liquidity requirements because my personal financial statement may not support the kind of asset ($3M – $5M) that I’m looking for now. This means I, too, will have to partner with someone to make up for this “shortcoming”.
Keep these key points in mind:
- Partner! You don’t need to limit yourself to your own personal financial statement. If you’re “weak” there, partner! Find one of your investors who complements your net worth and liquidity requirements.
- Go big as quickly as possible. I don’t want to have to personally guarantee a bunch of buildings – who does? Limit your personal liability as much as possible, negotiate the loan documents! Also shoot for bigger assets so that you get non-recourse loans.
- Talk to your lenders EARLY, long before you have your deal under contract, so that you better understand their underwriting requirements. This allows you to get your ducks in a row ahead of time so that you can close on your deals.
As with most things in business, it’s all about relationships. Build a relationship with your lenders NOW so that when you really need them, they’ll come through for you.
What kind of things are you hearing from your lenders?
Comment below and let’s discuss!