Connecticut Commercial Loans Made Easy

No More Mister Nice Guy!!!

noreply@blogger.com (markstp) — Wed, 20 Aug 2008 14:42:00 +0000

Times have changed. Gone are the days were on the second hole of golf with your Banker you casually mention that your company might miss its debt service covenant due to a delay in shipping a big order. "No Problem", your banker says as he crushes a drive down the middle of the fairway. Good laughs, good times.

Now, your Banker would lose the grip of his club sending his new titanium driver 50 yards down the fairway. Not only that, his boss in the next golf cart is already thinking about how this is going to play at credit committee.

How will it play? Well, not good. Whether its high profile real estate projects experiencing slight delays (read today's Wall Street Journal below the fold), or a business whose quarterly tax payment by the owner tripped a covenant, your banker doesn't care.

Loan portfolio problems persist everywhere and they affect you as a borrower - whether you are applying for credit or adjusting your existing credit agreement. Comforting factors such as the length of the banking relationship, being on the Bank's advisory board, donating to the Bank's charity of choice are butkus. You are in trouble.

The word I'm hearing is that Bank's have itchy trigger fingers resulting in pro-bank loan restructuring or even worse good companies or real estate deals being put in work-out. Loan restructuring usually means higher interest rates, higher fees, and tighter covenants - not to mention the legal costs to change the agreement.

Worse, Most if not all Banks are in the retrenchment mode when it comes to financing capital expenditure investments - especially to those companies that have tweaked the credit agreement. Short pay-back periods, production cost reductions, competitive advantage are reasons to invest in capital expenditures, however, those justifications are falling on deaf ears.

One local borrower - who wants to remain anonymous - mentioned in frustration: "We're just not getting any help from our Bank?".

What can you do? Unfortunately, the only way to make a Bank move on your request is to threaten to leave the Bank. Suddenly, everything makes sense to them - short payback periods, cost reductions leading to increased cash flow. Its sad that it takes that kind of threat given your perceived relationship between you and your Bank.

To accomplish this and to make the threat real, you should always keep other Bank loan officers at your beckon call. Also, you should prepare a financing package way in advance. Time is of the essence. Don't worry about crying wolf regarding threatening to leave or bringing another bank down the prim rose path because many bankers are like the caged mouse eating cheese only to be electrocuted. They keep coming back for more. My gut would time to choose the one banker that actually calls your bluff because he or she is truly has good business sense.

Submit your monthly, quarterly, annual financial information on time - meaning under the allotted time in your credit agreement. While seeming insignificant, being one day late submitting your financial statements is a technical default, immediately bringing your Banker to the restructuring table.

These are trying times for borrowers. Your Bank has become very transactional, versus, relationship driven. Meaning that you can throw away the past 15 years of on-time payments. If your having trouble, I would suggest also getting your attorney up to speed on your current issues. Then read the definition of the "Default Rate of Interest" in your credit agreement. Its not unusual to see your rate increase by 4% over night.

Good Luck.

Its been a long time and I Apologies!

noreply@blogger.com (markstp) — Mon, 18 Aug 2008 14:35:00 +0000

April 16, 2008 was my last post. Since that date, much has change in the commercial loan market and myself. One of the things that I've come to realize is that real estate investors and commercial business owners need more help than ever before with finding financing.

Abandoning these two important economic gas petals to the economy is not the right answer. Hiding behind a tough if not impossible commercial loan market is not the answer. I apologize for using these excuses as a way out of finding hard fought solutions for customers and prospects. You deserve better.

Now that I have that off my chest. The Commercial Loan Market is more strained and declining than the media is letting on. I laughed in a way that hid my nerves when I read recent news articles by local institutions such as the CBIA, and the SBA. Those two articles suggested that lending standards have not been tightened and in fact the Bankers polled in the articles suggested that they see customers and prospects being more cautious about future business expectations and therefore are postponing capital expansion. Sure, its not their fault, its the business owners not asking for loans!!!

Well I'd like for them to meet a successful owner of a insurance agency (been in the insurance business for over 30 years) in Hartford County who was looking to refinance an adjustable rate mortgage on her building. A mortgage rate that was adjusting to upwards to 13% as of this post. This person's credit was ok, not great, but enough to show that this person could handle their obligations. As of right now, this person who has a successful business and good personal credit can't find a loan to help the business stay competitive. The owner is approaching the point of laying of customer support staff because of the rising mortgage payment.

I'd like for them to meet the owner of an auto painting shop who has good credit, and has been in business for over 15 years and is an institution in his community. Finding a lender to refinancing him out of a hard money loan currently paying 12% has been impossible. This owner is worried about the current lender foreclosing on his property because the loan has matured. Each month his current lender charges the owner a $4,800 fee for not paying of the loan. All the lenders solicited to look at this loan avoided this loan like the plague. He employs six full time mechanics that he might have to lay-off because of his financial situation.

I'd like for them to meet a young entrepreneur that owns three commercial properties on a main street in a busy town. He owns a robust service business and his credit has been damaged by a dishonest residential loan broker who convinced this person that his personal mortgage refinance was going to close soon so don't pay your current mortgage. Well that is financial disaster for your credit report. Two of the commercial properties were leased out and cash flow positive. He wanted money for the third to bring it up to code so he can lease it out. He was asking a low Loan to Value on the properties that were already leased and cash flow positive. No dice. Lenders look for any excuse to say no - often times taking months to finally say no. They look at the personal credit and walked away. There so many reasons to justify the loan, but they needed only one to decline the loan.

Large borrowers aren't immune to what's going on. I've gotten calls from many of my old banking customers telling me that their banks are no longer funding capital expenditures required for future growth or required cost savings. Many of these companies employee well over 200 each. The lack of financing has further caused a business contraction and potential lay-offs.

So don't tell me that the credit crunch hasn't hit main street. I'm sure the business owners mentioned above where not asked in the polling conducted by these media institutions. I have an idea. Speak these business owners after they have to lay-off productive, important people because they are trying to meet their current loan payment that increases 15% a month.

The credit crunch is real, its here, and won't be gone for a long time. I know a lot of bankers that are telling me privately that their Bank's have posted "Closed for the Summer and Winter" signs on the Commercial Lending departments. Let's hope they might be open for the spring!

"Is it the beginning of the end or the end of the beginning."

noreply@blogger.com (markstp) — Wed, 16 Apr 2008 02:01:00 +0000

An article in Monday's Financial Times titled "The beginning of the end or the end of the beginning" filled me with enthusiasm that we were approaching the end of the "Credit Crisis". The author pointed to the market's gain since the Fed's bailout of Bear Stearns as the benchmark event that was the tipping point towards a bright future.

The author must of performed a gut check when GE shocked the market on Friday. Not only did GE's earnings debacle create concern regarding the health of the US economy (given GE's product diversification), but the write-downs in GE Capital and other Real Estate business lines reminded many that the credit crisis was still around. After deep thought the author published the article on Monday, perhaps I would have done the same.

On Monday, it was announced that Wachovia needed a $7 billion capital infusion due to write-downs and an unexpectedly worse US economy. This announcement came on the heels of Washington Mutual's $7 billion capital infusion by a private equity firm.

Wachovia's announcement peaked my interests because much of the capital infusion went to build capital reserves against a failing US economy. While the US economy was heading towards little to no growth projections prior to the credit crisis hitting the financial markets, the almost collapse of the banking system could mark the next phase of the credit turmoil: The Credit Crunch Phase.

Financial institutions can shore up capital ratios by injecting capital to the business and/or restricting lending. Withholding credit pinches the checkbooks of many main street businesses. Business owners then look to pare payrolls, shelve capital expenditures plans, and reduce other employee benefits (higher health care deductibles. This circular equation puts the economy in a precarious situation and could ultimately lead to a prolonged recession.

The point is with many financial stocks reporting earnings this week, we should get a glimpse into the health of the US financial system. J.P Morgan, Merril Lynch and Citigroup all report earnings this week with more to follow next week. Watch and read carefully the earnings reports and watch for signs of credit restrictions and dire predictions for the US economy. Pay close attention to the smaller regional banks that so far have been hidding behind the headlines.

So only after this and next week will we know if it's the beginning of the end or the end of the beginning.

FICO Scores Determine Your Commercial Loan Interest Rate

noreply@blogger.com (markstp) — Tue, 08 Apr 2008 02:31:00 +0000

"What is the borrower's mid-point FICO score?" This is a question I get from commercial loan underwriters within the first few minutes of a pre-qualification phone call. Why? Well, let's go over what they know before I call them about your opportunity.

Private lenders or commercial banks know the quality of the subject type property and the appropriate loan to value. They also know the likely default rate of the tenants in the property or of the owner occupied business in the building. They also have a feel for the economic circumstances surrounding the borrower's geography. If you look at their websites, you get a sense as to what these companies already know. So why do that want to know your mid-point FICO score.

Simply, FICO scores are the key determinate of the total risk premium applied to the lender's cost of funds. More simply, it affects your interest rate. Your FICO scores - for the most part - shows the lender your willingness to pay your bills, and also how leveraged is your personal cash flow. How much of an impact can your FICO score have?

Take the last two deals that I closed. Both deals involved similar mixed use properties. All properties had no vacancies, and good quality tenants. So when one deal had an interest rate of 10.25% and the other 7.25%, I knew the only difference was the borrowers' FICO score. The borrower with the lower interest rate had a FICO score approximately 95 points better than the other borrower. In dollars, the borrower with the lower (worse) FICO score paid approximately $18K a year in additional interest.

So be careful with your FICO score. It can cost or save you a lot of money on your commercial deal.

Remember This: There are a 1,000 of THEM and only ONE of YOU!!

noreply@blogger.com (markstp) — Tue, 01 Apr 2008 01:47:00 +0000

It can be down right scary. What if I say the wrong thing? What if my credit score isn't high enough? What if he shoots holes in my business plan? What if she doesn't believe that I can increase the occupancy rate to 90%? Oh, I need to get this loan closed in 30 days or I'll lose this great opportunity. My lender won't call me back. Have you felt these emotions when you last dealt with your bank? In short, do you look or feel like the picture below when dealing with the commercial loan process?

Let me tell you a secret. A secret that your banker doesn't want you to know. You can now obtain your loan to buy that business or buy that property from ANYWHERE on terms Better than what your loan officer can give you. You can buy that property with the help of a private lender in California. A hedge fund in Texas will help you acquire your competitor. Why or how did this happen? Well I'll get to that later, but it's important to know more about this nasty little secret.

Why doesn't your banker want you to know this devastating secret? Because, if you knew this secret (and now you do!) then he or she would have to return your phone calls or worse they would have to close your loan on your time table, versus, the banks. Better yet, they wouldn't be able to make you jump through hoops with questions and documents only to say NO leaving you with no options, and no time to find another lender. Well, thanks to the globalization of finance, Main Street USA now has access to capital from Asia, Europe, and all over the United States.

See, despite what you see on television regarding the residential mortgage crisis or the collapse of Bear Stearns, the United States has one of the most efficient capital markets system. Even with all of its warts (savings and loans debacle of the 80's, the collapse of the hedge fund Long Term Capital Management as examples of our warts), the United States' financial system attracts capital from all over the globe.

What this means for you- the Main Street investor or business owner? Well, the massive amounts of capital invested in the United States continues to chase fewer and fewer larger transactions. This puts pressure on putting the money to work, prompting these capital providers to lower their loan size requirements.

So now, that real estate owner in Newington looking for $50,000 cash out on his properties can obtain his loan from a private lender in Pennsylvania who's largest investors are private banking clients from Europe.

So the next time you call your banker, I bet he or she will take your call. Suddenly, they're hoping you take their loan; hoping that they don't say something that will make you go elsewhere. Remember, there are 1,000 of them and only One of You. You're driving the bus.

Storm Clouds - First Bolt of Lightning

noreply@blogger.com (markstp) — Fri, 21 Mar 2008 14:22:00 +0000

From time to time, I like to jump in and comment on the current lending environment facing commercial businesses and real estate investors. Today's entry, hopefully isn't a harbinger of things to come.

I know that several other large private lenders have closed up shop however, most of those closures stemmed from these lender's exposure to the residential market and not due to commercial. Well, we have our first potential casualty from a pure play commercial lender.

CIT Group yesterday drew down 100% on its $7.3 billion back up credit facility to meet current cash flow needs, and cash to service debt in the near term. CIT has to refinance approximately $3.0 billion in short term debt in 2008.

The reason for CIT's troubles stem from the disruption in the commercial paper market - which is almost non existent for lenders. Without access to the commercial paper market, CIT has to rely on other sources of funds, such as commercial deposits and other deposits. CIT's lack of a substantial deposit base created a liquidity crisis.

CIT management stated that the Company has the liquidity to fund its operations in 2008, but commented that it has to reduce its lending to new customers to preserve capital. This might be a sign of relief for CIT's current business customers, but it reduces the total amount of capital available to all commercial business and real estate investors.

The issue with the commercial paper market are intertwined with the general lack of investor confidence in the assets (loans) supporting these obligations. It started in the residential mortgage market, and know has swept into the commercial debt market.

The Fed and Wall Street hope that the recent liquidity added to the market will prime the pump to allow investors and lenders to create a floor in the value of these assets supporting the obligations. A floor, created by good old buying and selling (trading) that is the foundation of our market system, will signal to all parties that we reached the bottom of the residential and now commercial debt market leaving only upward pressure on asset values. Upward movement in asset values with increase the acceptance and ability of investors to buy lender ogligations. Let's hope they are right. If not, the storm could turn into a hurricane.

Real Small Business Loans for Real Small Businesses

noreply@blogger.com (markstp) — Fri, 21 Mar 2008 00:54:00 +0000

If you were looking for a $300,000 business loan, would you pay and additional $67,000 over three years in order to get a two percentage point reduction in the interest rate?

Unlikely.

But that's what plenty of small business owners do because they seek bank financing with seemingly low rates of interest, versus a so-called stated income/asset loan that carries an apparently higher interest rate.

How can this be?

Simple. The low rate loan is a full documentation, conventional loan. The seemingly higher rate loan, the stated income/asset loan, requires limited documentation and no income verification. For small business owners, there is a world of difference. The reason is because the owner of a small and or cash based business may have a very low salary, but quite legitimately derive economic value from the business in excess of $100,000. But stating this to satisfy a bank can at the same time provoke tax authorities, and generate significantly more taxes well into the future.

Thus the savings from the apparently lower rate of interest are illusory. Worse, because of potential tax liabilities, low rate loans may result in an effective interest rate that is much, much higher.

We are all brought up to believe that banks finance businesses. And there is a myth that small banks and small businesses fit hand and glove with one another. But the truth is that banks and small businesses are actually a tough fit.

The bankers aren't bad guys. It's simply that banks - even regional and community banks that have a vested interested in funding businesses where they operate - are structurally incapable of serving the needs of small and or cash based businesses. Banks need plenty of hard assets to collateralize loans. In addition, they are subject to scrutiny by federal regulators on their underwriting policies and practices, and have an expensive monitoring process that favor larger borrowers - those that need to borrow $500,000 to $1 million or more.

By contrast, smaller, cash based businesses typically do not possess a lot of hard assets, may have uneven financial performance that make regulators wince, and typically require loans of less than $1 million. The reality of this "structural mismatch" can be vexing and frustrating for small business owners who often diligently visit every bank in town only to get turned down by each one.

For these reasons, non bank lenders and stated income/asset programs can be a viable alternative for cash businesses, 'mom and pop' shops, self employed individuals, businesses with environmentally sensitive properties (i.e. auto repair shops, dry cleaners) as well as property owners that want to cash out, or leverage up to purchase additional properties. In the highly regulated environment of a conventional bank, these borrowers present insurmountable obstacles. In the more entrepreneurially driven non bank lender environment, these borrowers present a myriad of opportunities for which creative solutions can be developed.

What is the secret of non bank lenders that offer stated income/asset loans? First, they operate in an underserved market: small businesses seeking loans of less than $1 million. By virtue of this, non bank lenders can identify promising businesses that traditional banks would not even see. Second, non bank lenders are not regulated. This means they can adopt policies that while sound, would nonetheless go against the grain of federal regulators provoking questions and inquiries that bank executives would like to avoid altogether. Finally, non bank lenders believe in the value of real property as collateral. By lending prudently against the value of real property, non bank lenders need go no further in assuring the safety of their capital. Putting all these factors together means that non bank lenders offering stated income/asset programs can provide small businesses with solutions that are more consistent with the challenges they face.

For example, many traditional lenders require cross collateral agreements. These are agreements in which the borrower, after pledging all of the businesses' assets and real property as collateral, pledge their personal property as well. This arrangement can complicate loans, especially when there are multiple business owners whose active participation in the business may vary. Because stated income lenders focus on the underlying value of the businesses' real estate, in addition to its cashflow, they generally do not require cross collateral agreements.

Stated income/asset lenders are also more comfortable with so called cash out loans. For example, suppose you own a property that houses your business, and you want to leverage the value of your equity, and take cash out. Perhaps this cash will be used to expand the business. Or perhaps you might view this cash as a just reward for years of carefully managing the business and the property.

Traditional bank lenders are uncomfortable with cash out loans. They often feel that such arrangements leave them vulnerable. By contrast, stated income/asset lenders, which again place an emphasis not only on the business's cash flow but the underlying property as well, actively seek such loans. Their appetite for these loans is a valuable source of liquidity for small business owners.

As one more example of how stated income/asset lenders are more geared to the needs of small businesses, consider typical loan covenants. Traditional lenders often seek the right to audit the books of the borrower and have the borrower issue a covenant pledging that the business will perform at its current level or better. A breach of this covenant, over which the small business owner may not have complete control, can result in the borrower being in default, and the lender initiating foreclosure proceedings.

Again, there is nothing wrong with this per se. After all because banks are the stewards of consumer deposits that are insured by federal funds, i.e. taxpayer dollars, they must avoid risk at all costs. This is why banks operate in what is often characterized as 'an abundance of caution mode,' and adds bulk to the explanation of why banks are not built for the kinds of risks that small businesses typically present.

It also explains why there is such a void in the market for loan and credit services to small businesses. However, stated income/asset lenders have stepped into this void and are actively seeking out companies to provide loan solutions to help businesses maintain their track record of success, or take a giant step forward to the next level.

How Real Estate Affects the Bottom Line for Small Businesses

noreply@blogger.com (markstp) — Fri, 14 Mar 2008 13:39:00 +0000

Perhaps the most striking feature about the money made by homeowners from their house was how little of it was intentional. For many, a mortgage payment was simply a substitute for the monthly rent payment. But over time, loan balances went down, values went up, and suddenly there's a half a million in equity sitting on the table.

Although a similar opportunity exists for small businesses, fewer entrepreneurs take the leap. Running a business is challenging enough, why add the headache of owning additional property? This may be true, but buying real estate to house your business - as opposed to renting - can have a material impact on your return from the business and your overall wealth.

To see this concept in action, consider the performance our hypothetical retailer, The Speed Shop, which sells automotive products, before and after the purchase of real estate.

For years, The Speed Shop, provided a nice living for its owner. Located in the suburb of a major metropolitan area, the business, a subchapter S corporation, consistently generated $750,000 in sales and distributed net profits of 5% or about $37,500 after the payment of a $60,000 salary to the owner. Since the business was stable, the owner typically took the net profits out of the business in the form of a cash payment.

Suddenly, the owner receives a call one day. The building owner has died. The executor of the estate would like to know if he would be interested in buying the building for $750,000? Because the owner had invested his bonuses wisely over the past 10 years, there was no question he had the cash to make a 40% down payment of $300,000.

But the question became would the purchase of the building have a positive or negative effect on the Speed Shop's owner? Let's assume the owner buys the building personally, and rents it to the business to see how far out ahead he might come after 10 years, versus continuing to rent.

If the $450,000 balance was financed with a 6.25% adjustable rate mortgage, the monthly principal and interest payment would be $2,770, if amortized on a 30 year basis. Including the annual taxes of $7,200 increases the monthly payment to $3,370. This is less than the current monthly rent of $6,500 that the company pays, so the transaction is off to a good start.

But let's be conservative and assume that the Speed Shop's owner spends $37,500 annually on maintenance and operating expenses for the building. This $37,500 is annual difference between the old rental payments and the new mortgage and tax payments.

Now we need to make two adjustments to account for depreciation and principal contributions.

Let's take principal first. The mortgage payments of $2,770 per month which total $33,240 annually contain about $5,300 in principal payments in the first year. These principal payments cannot be expensed.

On the other side, there's depreciation to consider. Net of land, which cannot be depreciated, the value of the building is $675,000 which is $750,000 less an assignment to the value of the land at about $75,000 or 10% of the total value of the property. The useful life prescribed by the IRS for non residential commercial real estate is 39 years. Therefore the annual depreciation expense for the property is $17,308 which is the $675,000 basis divided by the 39 year useful life.

The income statement for the first year will look like this:

Income: $78,000
Expenses
Mortgage Payments
Net of Principal $27,940
Taxes $7,200
Operating Expenses $37,500
Depreciation $17,308
Total Expenses $89,948
Net Loss $11,948

The landlord feels none of this net loss because it's delivered in large measure by the non cash depreciation expense. On the down side however, he also doesn't really feel the increase in equity of $5,300, because, despite the lower mortgage balance, the mortgage payment does not change.

Regardless, what's important is the ability of the landlord to take this loss and net it against the profits he receives from his retail business that will ultimately have a material impact on his wealth.

Remember the 5%, or $37,500 in profits? Thanks to the loss on the building the owner will pay taxes on just $25,553 ($37,500 profits - $11,948 loss from real estate). In a 35% bracket, this means avoided taxes of $4,181.

Said differently, the Speed Shop's net margin would have to increase to 5.86%, to leave its owner with the same amount of cash after taxes. This represents an astounding 17.2% (0.86% / 5.00%) increase in net realized profits to the owner.

It's important to keep in mind however that the feds, as a general rule do not like to see passive income (i.e., such as income from a real estate investment) offsetting active income, (i.e., such as income from running a retail operation). There are rules that govern limits to the offsets over certain amounts. And if you get into a discussion with the Internal Revenue Service that your ownership and management of the building is active, you might very well be unable to get them to see your point of view.

Now project 10 years into the future, and assume that rather than selling the business, the owner simply shuts it down and sells the building. Also assume that after the first year he replaced the 6.25% adjustable rate mortgage with 9.87% permanent financing. How did he do? At the end of 10 years, he owed the bank $410,000. However because real state values went up by an average of 7% per year, he sold the building for $1.47 million. After paying off the mortgage, the Speed Shop's owner has $1.06 million.

True, he doesn't get to pocket this. He must pay long term capital gains taxes. And all that depreciation he took for so many years comes home to roost, in lowering the cost of the building, and in turn increasing the capital gains tax owed. In this case the $17,308 in annual depreciation reduced the owner's cost basis by $173,080 over 10 years. Said differently, the owner must now pay taxes on this so called "unrecaptured" depreciation at a rate of 25%. The balance of the gain will be taxed at the recently enacted long term capital gains rates of 15%.

However this must be weighed against the avoided taxes of $4,181 in the first year and $9,800 in years two through 10 (as a result of a mortgage with a higher interest rate). But more importantly it must also be weighed against the $634,692 ($1.06 million proceeds - $125,308 capital gains taxes - $300,000 initial investment) earned on the real estate investment after payment of all long term capital gains taxes.

The average after tax gain of $63,469 ($634,692/10 years) per year is the equivalent of $97,644 pre tax income in a 35% bracket. Adding this to the owner's salary and profit distribution of $97,500, means that diverting the cashflow that normally went into rent toward ownership of real estate doubled his income.

As you can see, it's as if he made the business twice as big but never added a single square foot to the operation. That being said, it's safe to say that adding real estate into the business equation can have a very material effect on the wealth of principals in a business.

Simple, But Required Real Estate Calculations Every Investor Should Know!!

noreply@blogger.com (markstp) — Thu, 13 Mar 2008 13:01:00 +0000

THE THREE COMMON REAL ESTATE INVESTING CALCULATIONS

Crunching the numbers can be one of the most difficult part of the financial due diligence on a property. However, it is important to know what you are getting into financially.
The following key terms are the most important figures you will need to calculate to determine if a property is right for you.

Net Operating Income (NOI):
The net operating income or NOI is the dollar amount that’s left over after you collect all your income (rent) and pay out you operating expenses. This amount is what is used to pay the mortgage, and what’s left after the mortgage payment goes into your pocket! Here is the equation:

Net Operating Income = effective gross income – operating expenses

What is effective gross income? Your effective gross income is the net amount of income after vacancies with the property.

What are operating expenses? Your operating expenses of the property include taxes, insurance, utilities, management fees, payroll, landscaping, maintenance, supplies, and repairs.

Cash-on cash Return:

The cash-on-cash return measures how long it takes for you down payment to come back to you. For example, if your down payment was $20,000 on a property how soon would your monthly cash flow (NOI – Debt Payments) it takes to add up to $20,000. General real estate guidelines suggest that a 10% or greater cash-on-cash return is preferred.

Capitalization Rate or Cap Rate:
The capitalization rate is a measure of a property’s performance without considering the mortgage financing. If you paid all cash for the investment, how much money would it make? What’s the return on your cash outlay? Cap rate is a standard used industry wide.

Cap Rate = net operating income / sales price

Since a cap rate measures the property’s profitability it can also help you determine the appropriate sales price for the property. For example, let’s say you want to earn at least 10% on your property investments. The property you are currently evaluating is listed at $2,750,000 and has a $250,000 NOI. Well for you to earn 10% on your money, you would want to negotiate a purchase price of $2,500,000 ($250,000 / 10%).

How Banks Affect Business Value!!

noreply@blogger.com (markstp) — Wed, 12 Mar 2008 12:21:00 +0000

I THOUGHT MY BUSINESS WAS WORTH $2,000,000

For most businesses sold in America, the buyer has to rely on bank financing to fund the majority of the purchase price leaving a few dollars for an equity contribution to the purchase price. Banks have very strict credit lending standards, and typically look for three sources of repayment: Cash flow, Collateral, and Personal guarantee. What banks don’t tell you is that the primary governor on the availability of a loan is collateral.

Loan amounts are based on collateral values, then cash flow coverage. Furthermore, banks hold the cards in terms of what is acceptable collateral. While a buyer or you as the seller might think your customer list is the largest component of value for your business, this means nothing from a collateral support to a bank. In other words, if I took your customer list to a bank and asked for a loan they would simply laugh.

Banks best form of collateral includes account receivables, raw or finished goods inventory, fixed assets, and real estate. All other assets are nice and perhaps valuable, but not to a bank. Banks, however, like to margin against the full value of the assets, something called an advance rate. Yes, that’s right a bank will not lend to you 100% of the value of your assets (not even CASH). The following table shows the range of advance rates for each asset:

Lending Institutions Asset Advance Rates

Advance Rate Range
Asset Low end High End
Cash 90% 100%
Account Receivable 60% 85%
Raw and Finished Inventory 25% 50%
Fixed Assets 75% 90%
Real Estate 70% 85%

So what does this mean to you, the seller. Well if your available buyers are looking to rely on bank financing to buy your business, the buyer would be required to come up with a substantial down payment to facilitate the difference between the asset value and the advance rates. The ability of the buyer to raise this money creates risk for you in terms that you perhaps never thought of.

Example:
Let’s assume that you and the buyer agree on a purchase price of $2,000,000. Your business earns $600,000 in annual cash flow. This would create a 3.3x multiple. You feel that this multiple and value fully captures the essence of your business. However, the buyer is looking to borrow from a bank to fund the purchase price. So let’s look at the following scenario:

Asset Asset Value Advance Rate Net Lendable Value Purchase Price
Account Receivable $300,000 80% $240,000 $2,000,000
Finished Goods Inv. $200,000 50% $100,000
Fixed Assets $100,000 90% $90,000
Real Estate $500,000 75% $375,000
Totals $1,100,000 $805,000 ($1,195,000)

As you can see, the buyer would have to come up with $1,195,000 in cash to cover that shortfall from the bank. This is a difficult proposition for most buyers for companies of this size. While there might be specific State or Federal (SBA) programs that might increase the advance rate for each of these assets, the impact will not move the needle in a significant way.

So the buyer has three options: Bring in a partner, Walk away from the transaction, or Seller financing. In most situations the sellers are asked to provide seller financing to bridge the gap ($1,190,000) in the above example. So let’s say that you agree to finance the gap, and you and the buyer sign a ten year $1,195,000, 10% note subordinated to the bank, that’s right subordinated to the bank. This means that the bank gets its money before you and in the event of liquidation they get the proceeds before you do.

At closing you receive $810,000 in cash and a $1,195,000 note earning interest at 10% but doesn’t amortize until five years from closing. In total. you received $2,000,000 in consideration, but not $2,000,000 in cash. Using a 10% discount rate over ten years, the present value of your note is really $439,594.00. The following table shows the real value of your business, driven mostly by the advance rates of today’s financial institutions:

What’s my business really Worth?

Consideration Total Consideration Adj. Consideration
Cash $810,000 $810,000
Note $1,190,000 $439,594
Total $2,000,000 $1,249,584

So what started out as a $2,000,000 purchase price, turned into real consideration of $1,249,584 – a $750,000 difference. Wow, bank financing does affect the value of a business.

Easy Bake Commercial Loan Dictionary!!

noreply@blogger.com (markstp) — Tue, 11 Mar 2008 13:09:00 +0000

EASY BAKE COMMERCIAL LOAN DICTIONARY

When its time to go talk to the bank do bad memories or nightmares come to mind. They asked you questions with words and terms that sound from a far, far away land. Well, I’ve compiled a list of the most important and interesting terms for the next time you talk to a bank or more importantly to help better you understand before signing that loan!

Advance Rates: This rate expressed as a percentage determines how much the Bank will lend on certain assets. For example, accounts receivable typically carries an 80% advance rate. So if your company had $100,000 in account receivable, the bank would lend you $80,000. Machinery and equipment and inventory are typically margined by advance rates. Real Property typically is valued at 80% of the appraised value.

Affirmative Covenants: Affirmative covenants are the contractual provisions in a loan that the company and its management agree to fulfill after the loan is complete. In other words, this is what you PROMISE TO MAINTAIN OR DUE POST CLOSING. Common affirmative covenants include:
· Access to records. The company will give the investor or bank and its representative’s reasonable access to company records and personnel.
· Financial reports. The company will furnish the bank with regular financial reports on the status of the company. Balance sheets, profit and loss statements, and cash flow statements are usually provided monthly, quarterly, and annually. Audited annual statements are often required. Sometimes a short "state of the company" statement is also required from the company president on a monthly basis.
· Budgets. The company will prepare annual budgets which must be approved by the board of directors.
· Existence and maintenance of property. The company will preserve its corporate existence and all rights necessary to conducts its business and own its properties. The company will keep its properties in good repair.
· Insurance. The company will maintain adequate insurance. Often, the company also agrees to purchase key man insurance on the lives of management.
· Payment of debts and taxes. The company will pay its debts and taxes in accordance with normal terms.
· Compliance with laws and agreements. The company will comply with all laws applicable to it and perform its obligations under its agreements.
· Litigation and other notices. The bank will be promptly notified of any lawsuit, default under a major agreement, or other event that could have a material adverse effect on the company or its operations.
· Proprietary rights protection. The company will take reasonable steps to protect its patents, trade secrets and copyrights. These steps may include securing secrecy or non-competition agreements from company employees.
· Use of proceeds. The company will use the funds provided by the investor or in the manner described typically in the loan application.
· Accounting system. The company will maintain its current accounting system.

Borrowing Base: A borrowing base typically a monthly calculation that is attached to a line of credit or revolver. The borrowing base is the total amount of lendable assets – after the application of an advance rate. This number represents the total amount a bank will lend you for that month. If your borrowing base falls below the amount borrowed the bank will seek a reduction on the line of credit balance to below the new borrowing base.

Capitalization Rate or Cap Rate:
The capitalization rate is a measure of a property’s performance without considering any mortgage financing. If you paid all cash for the investment, how much money would it make? What’s the return on your cash outlay? Cap rate is a standard used industry wide.

Cap Rate = net operating income / sales price

Since a cap rate measures the property’s profitability it can also help you determine the appropriate sales price for the property. For example, let’s say you want to earn at least 10% on your property investments. The property you are currently evaluating is listed at $2,750,000 and has a $250,000 NOI. Well for you to earn 10% on your money, you would want to negotiate a purchase price of $2,500,000 ($250,000 / 10%).

Cash-on cash Return:

The cash-on-cash return measures how long it takes for your down payment to come back to you. For example, if your down payment was $20,000 on a property how soon would your monthly cash flow (NOI – Debt Payments) takes to add up to $20,000. General real estate guidelines suggest that a 10% or greater cash-on-cash return is preferred.

Defaults or Events of Default: This is here as a reminder that you and your attorney need to understand what triggers a default in your loan. A default can result in higher fees, higher interest rate, and even an acceleration of the loan – meaning the bank wants the entire loan paid back today. Other defined terms in this dictionary are triggers for default such as affirmative and negative covenants.

LIBOR Rate: LIBOR stands for the London Interbank Offering Rate. It is the basic short-term rate of interest in the Eurodollar market and the rate to which many Eurodollar loans and deposits are tied. The LIBOR is similar in concept to that of the prime rate in the United States except that it is less subject to individual bank management.

Loan to Value: The ratio of money borrowed on a property to the property's fair market value. On a purchase contract, the bank will use the lesser of the appraised value or the purchase price of the property. Most commercial banks advance 80% on the appraised value of the property.

Interest Rate Swap: A deal between banks or companies where borrowers switch floating-rate loans for fixed rate loans. These can be either the same or different currencies. The advantage to this is that one company may have access to lower fixed rates and another company may have access to lower floating rates... so they trade.

Prime Rate: The interest rate that commercial banks charge their most credit-worthy customers. Generally a bank's best customers consist of large corporations. Default risk is the main determiner of the interest rate a bank will charge a borrower. Because a bank's best customers have little chance of defaulting, the bank can charge them a rate that is lower than the rate that would be charged to a customer who has a higher likelihood of defaulting on a loan.

Material Adverse Change: While this might seem obvious, but this provision in a loan agreement can give the bank substantial room to call a loan. Essentially, this provision protects the bank in the event a negative event happens to the borrower that would impair the borrower’s ability to pay back the loan. Examples might include the loss of a big customer, a substantial lawsuit, loss of a key owner/manager. Many borrowers don’t try to limit the range of this provision – What is Material? If its not changed then the definition is defined by how the bank wants to define it. Make sure you and your lawyer look at this provision and are comfortable with its range.

Negative Covenants:
Think of a negative covenant as a promise not to do something. Usually, negative covenants limit the amount of dividends a firm can pay to shareholders and restrict the ability of the firm to issue additional debt. Generally, the more negative covenants exist in a loan, the lower the interest rate on the debt will be since the restrictive covenants make the loan safer in the eyes of bank. This is very important aspect of the loan agreement. For example, let's say you bought a property for its net monthly cash flow. If your loan agreemetn prevents dividends or distriubtions then any payment of the net monthly cash flow would be a violation of the loan agreement.

Net Operating Income:
The net operating income or NOI is the dollar amount that’s left over after you collect all your income (rent) and pay out you operating expenses. This amount is what is used to pay the mortgage, and what’s left after the mortgage payment goes into your pocket! Here is the equation:

Net Operating Income = effective gross income – operating expenses

What is effective gross income? Your effective gross income is the net amount of income after vacancies with the property.
What are operating expenses? Your operating expenses of the property include taxes, insurance, utilities, management fees, payroll, landscaping, maintenance, supplies, and repairs.

Due Diligence Checklist for the First Time Commercial Real Estate Buyer!

noreply@blogger.com (markstp) — Mon, 10 Mar 2008 15:13:00 +0000

Due diligence is the process of doing your homework on the property that you’re thinking about buying as an investment. It’s the process of checking, double-checking, and confirming any important information that was used to determine whether the property is good, average, or a bad deal.

The following list regarding due diligence is not all encompassing and you should explore every detail on a property before pulling the trigger. It is also important to recognize what you know and don’t know. Hiring the right advisors (accountant, inspector, and lawyer) is very important and valuable. While being expensive, remember this: “Being cheap is sometime expensive”. The due diligence items usually fall into three categories: Physical, Financial, and Legal.

Physical Due Diligence:

Site plans and specifications: This group of documents includes all the construction documents, building plans and schematics, floor plans, and use of the land documents.
Photos of the property: Photos of the exterior, interiors, and the surrounding land and structures should be taken.
Structural Inspection: Inspect the walls, roofs, and foundation.
Interior Systems Inspection: Inspect the interior of the property for wear and tear, including items such as doors, windows, and weatherproofing. Then inquire about the age of the roof, any building code violations, its federal compliance, and the site improvements.
Mechanical and Electrical Inspection: Make sure that every mechanical and electrical system is inspected. Such systems include heating, ventilation, air conditioning, plumbing systems, and all electrical power systems and controls.
List of Capital Improvements Performed: Obtain receipts and documents for any capital improvements that were made. Collect these for any improvements over the past five years.
Pest Inspection: On some types of building, an inspection for pests, such as termites, may take place. Most apartment buildings have this inspection done as part of a lender requirement.

Financial Due Diligence:

Income and Expense Statements: You should obtain annual income and expense statements for the past three years.
Rent Rolls: A rent roll is essentially an attendance sheet for all tenants. It displays the tenant name, unit space, amount of rent paid, move-in date, lease expiration date, and security deposit.
Tax Returns: Obtain the property’s tax returns for the past three years. Add up all the income and expenses shown on the tax returns. These numbers should match those from the seller’s income and expense statements.
Lease Agreements: A lease agreement can be a complex legal document. If all of the leases are the same, such as in an apartment building, have an attorney review the fist few to make sure they’re valid.
Utility Bills: Obtain the past two years’ worth of actual utility bills for the property. These bills include electricity, gas, water, sewer, trash, telephone, cable and Internet service bills. Compare the totals of each utility category to the seller’s total given on the expense statements.
Property Tax Bills: Obtain the past two years’ worth of property tax bills. Verify the amounts with those given on the seller’s expense statements.

Legal Due Diligence:

Environmental Inspection: The environmental inspection most often used is called a Phase I Environment Site Assessment. During this inspection the inspector explores the past use of the property and the surrounding area, looking for onsite and offsite environmental problems and liabilities.
Survey and Title Inspection: With this inspection, a title company can verify the property size and that the title report has the same description as the survey. You can also review any easements or encroachments.
Inspection for Building Code Violations: If a violation occurs after a building is built, it’s called a non-conforming use and is considered to be grandfathered in.
Zoning Code: You need to review the town’s zoning ordinances to make sure that the property’s use complies with what it’s legally zoned for. Its used illegally the property can be shut down.
Insurance Policy: The property’s insurance policy can be a treasure trove of information if you can get the claims history.
Licenses, Permits, or Certifications: Often times, you’re required to post business licenses, permits or certificates. Make sure that you’re proactive in notification of new ownership to avoid hefty fines.
Service and Vendor Contracts: Review all service and vendor contracts to make sure that you have the right to choose or discontinue the services. These services may include maintenance and landscaping.
Personal Property Inventory: Obtain a list of all personal items, such as equipment, tools, computers, furniture, supplies and appliances, that re to remain with the new owner. Document all these personal items in writing or consider them gone.
Police Reports: Determine past and current police reports by calling the local police department. Review the type and frequency of calls to the property. Know what’s going on before you buy.

Now, remember that this list is a start and not all encompassing. Your commercial real estate team should consist of a good lawyer, commercial real estate broker, inspectors, and financing partner (I know a good one!). Good Luck.

Storm Clouds Surrounding the Commercial Loan Market!!

noreply@blogger.com (markstp) — Fri, 07 Mar 2008 14:12:00 +0000

"No, as of March 1st, we are no longer offering commercial mortgages with Loan to Values (LTV's) in excess of 85%". That's the message I got yesterday from a commercial lender who prior to March 1st was aggressively offering 95% LTV's. What happened at midnight February 29th? Did the extra day (leap year) in February cause most lenders to change so abruptly?

Here are some of the ingredients prompting the change: This past week, the Wall Street Journal dedicated several columns suggesting that the commercial market was on its way down. To summarize, the Wall Street Journal showed that nonresidential construction was down 1.7% in January versus the prior month, office space sales declined 42% in the fourth quarter of 2007 right as the credit tightening began, and that The International Council of Shopping Centers announced that U.S. store closures could reach 5,770 up from 4,603 last year.

More storm clouds are on the horizon according to another article quoted in the Wall Street Journal. The article suggested that U.S.'s community banks are sitting on a commercial loan time bomb. Community banks have migrated to underwriting more commercial loans as they've been pushed out of the residential mortgage market by Wall Street money. "Small and midsized banks, with less than $10 billion in assets, have a total of $323 billion outstanding loans", the article stated. This represents approximately 285% of the remaining banks' capital.

Let's speculate that approximately 1% of those loans referenced above were written off by the community banks - for a total of $3 billion write off. Not only would that result in several community closing, but it would also reduce the lending capacity of those institutions by at least $32 billion (using a 10x factor due to the leverage employed by most banks). That means $32 billion in potential loans to you and me to buy real estate would evaporate.

Is the sky falling? No, not exactly.

Commercial loan delinquencies are still low at 1.94% in the forth quarter of 2007 (it did rise modestly over the prior year). In the 1990's the commercial loan delinquencies reached 10%, so we still have a long way to go. Many experts suggest the most weakness in the retail segment, which is most susceptible to the downward movement in the national economy. So what does all this mean to you and me, who deal in the small balance commercial loan market? Here's what I think:

Higher equity requirements. A contraction in the loan to value ratio means higher equity contributions by the owner/investor. Solution: If the cash isn't available to increase the equity contribution to complete the deal, approach the seller about a seller second mortgage. Your primary financing institution will look at the seller second as quasi-equity due to their 1st priority in the transaction.

As properties come under increased scrutiny, the borrower's underlying credit will become increasingly important. So having a healthy credit score backed by personal liquidity will help you get that deal completed.

Find other creative ways to finance the deal. For example, you could arrange a master lease agreement with an option to buy (at the current market value) with the owner. Under the master lease agreement you pay the owner a monthly lease payment but you run the property including collecting rent and paying expenses. Your goal is to then increase the value of the property and cash flow during the term of the lease (usually three to five years). Remember your option is based on the value today, not the value your going to create during the lease term. You could also negotiate that a portion of your lease payment go towards the option price.

Buy on option on the property today for a small upfront fee. This locks up the property while you find a solution to the financing arrangement. Make sure that the upfront option price goes towards the purchase price.

Keep looking at the horizon for those storm clouds and I'll be happy to be your real estate weatherman!! Remember good deals get done!

Help! I'm self employed. How can I get a commercial mortgage?

noreply@blogger.com (markstp) — Thu, 06 Mar 2008 17:01:00 +0000

The majority of small businesses owners are self employed (including myself) making it very difficult to document your income to qualify for a commercial mortgage (even for a residential mortgage). So what can you being doing to prepare for the time when you want to buy that building you've been occupying since you started your business. Here it goes:

First, and most important is to keep your credit scores as high as possible. Typically stated income lenders start around 600 and above.
Have your tax returns, including supporting schedules such as Schedule E and K-1s.
Develop a relationship with an accountant. Have them prepare your tax return and business financial statements. Most lenders will require a letter from your account supporting your self employment status.
Buy a high quality property that has nice cash flow and Cap Rate. Commercial lenders look at the property first then the borrower's credit. If the property produces good cash flow (1.25x Debt Service Coverage Ratio and above), and has good quality tenants supported by strong leases, then the lender will rely less on the borrower's credit.
Have established checking accounts for you and your business. Show adequate reserves in those accounts. Reserves mean a buffer amount of cash in case your income or the property's income stops).
Have strong assets on your balance sheet. Equity in a house or strong liquid assets including those in a deferred retirement plan all help. If you show a healthy balance sheet that helps. Remember, assets will be verified (through statements or calling the bank) even though your income is stated.
Consider putting more than 20% down (some lenders may require more) on the property. Lenders love equity cushions, because it protects their interests. So a high down payment may mean a faster approval.
Have the appropriate business license. I know it sounds silly but one way to prove that your are self employed is to have a copy of a valid license.

Having or following these items should lead you to a successful loan closing!! Good Luck.

Top Ten Red Flags your lender doesn't want to see and hear!

noreply@blogger.com (markstp) — Mon, 25 Feb 2008 16:15:00 +0000

Today, I'm going to focus on post loan closing aspects of your relationship with your lender - that's right you still have to deal with your lender after the money is in your account. This post might be more pointent to a business loan, but some red flags are not exclusive to only business loans and apply to real estate loans. Here are the top ten Red Flags your lender never wants to see our hear!!!

Late Payments. While one or so per year might not raise the hair on the back of your loan officer, a series of late payments will prompt a phone call by your lender to you asking if everything is ok. Why? Usually after a payment is five days late, the late payment shows up on your loan officer's boss's desk!! Remember everything falls downhill.
Overdrafts. There are two types of overdrafts a lender sees when he drinks his coffee in the morning. Uncollected Funds or just a plain old overdraft where there is not money in the account and no deposit in the system. Uncollected funds are deposits made to your company's DDA and are in the process of being cleared (this can take 3 to 7 business days). Uncollected funds overdraft are still bad, but not as significant as a bare naked overdraft. A banker will probably pay on the presented checks in a uncollected funds situation, but not on a true overdraft. A series of overdrafts are a serious problem that will need to be addresses by the Bank and you. An overdraft report and the number of days the acount has been overdrawn can go to the highest level of the bank.
Late Financial Statements. Late finanacial statemetns can be an alarm to the bank that there might be serious problems at your company. Loan agreements provide a period of time to get financial statements completed and submitted to the bank. Many borrowers don't even know that they owe the bank information, because at closing they are mostly worried that the rate and term is correct on the note. Create a tracking list of all documents required by the bank, seperated by monthly items, quarterly and annually. This may sound crazy but late statements is a default of your loan agreement and the Bank could call the loan.
No Communication with the Bank - No Returned Phone Calls. A series of phone calls not returned to your banker sends up a red flag that something is going on. The bank debt on your balance sheet is probably over 90% of your total funded liabilities. So this important creditor needs to keep in constant communication. Silence is worrisome for a banker. The banker could be thinking that your losing money, lost a key customer, or what ever else might pop up in their mind.
Frequent covenant defaults. Records are meant to be broken, but not loan covenants. A loan officer has to get waivers approved internally and face hundreds of questions about the state of your company and frankly your lack of respect to the loan agreement signed at the closing table.
Rumors. This one is harder to control but you must be aware of the impact of rumors about your company getting to your bank. Your bank might lend to your competitor, customers, and might even know your accountant and lawyer. A comment like "Hey, Tim Banker you might want to get over to Joe's Machine Shop ASAP! from your accountant might create a red flag.
Borrowing Base Over Advances. For those with lines of credit tied to borrowing bases - an overadvance sitiuation is an immediate alarm to a banker. An overadvance occurrs when you revolver balance exceeds the assets used to collaterialize your line of credit. If it can be cleared up quickly (days) then its not so bad, but if its a long term issues then there will be problems. See if your line balance, which should rise and fall with your current assets, exeeds you current assets, then most likely your losing money or the quality of your assets might be question - accounts receivable collectability for example.
That new beach house and Mercedes that you just bought. Believe it or not a dramatic change in your lifestyle would peak the interest of your banker. Your banker would begin to question you commitment to the business, would wonder if the loan proceeds when to buy the car and beach house, and if any other debt was issues to the owner to acquire such cool things.
The loss of a key employee, partner, or customer. This is an obvious one, but one aspect of this might lose your bankers trust. If you delay in telling your banker and worse your banker finds out from someone else would be disastorous.
We don't have money to fund payroll! This is one of the most debilitating call a banker can receive from a company - short of a call to let your banker your filing for bankcruptcy. Payroll is the most sensitive expenses a company faces each week or every other week. It also quickly sends a message that things are not right at your company. You also forced your banker into a corner - which no loan officer wants to be in. Avoid this one at all costs.

Lessons from the top and my old boss??!!!!!!

noreply@blogger.com (markstp) — Fri, 22 Feb 2008 20:27:00 +0000

When pricing out a loan, my old boss would tell me that "pigs get fed and hogs get slaughtered". After reading several articles on Harry Macklowe's problems with his lenders, my old boss's voice echoed in my head. Ironically, Mr. Macklowe's issues can provide a lesson to all real estate investors: Don't get greedy.

For those who might not be following the situation, Mr. Macklowe - a very successful real estate investor - is tied in a knot with his Senior, Subordinated and Bridge Loan lenders over the $7.1 billion he borrowed (fifteen months ago) to buy seven Manhattan office buildings. To get the deal completed he offered his crown jewel as collateral to secure a $1.2 billion short term bridge loan from Fortress Investment Group. The crown jewel is the prestigous General Motors building on the southeast corner of Central Park. Mr. Macklowe purchased the General Motors building for $1.4 billion from Donald Trump, who bought the approximately 2.0 million s.f. office building for $800 million in 1998.

Well, last week, Mr. Macklowe turn over the property to Fortress, but kept the title to avoid expensive New York City transfer taxes. Yesterday, three bidders put forth term sheets to acquire the property for $3.0 billion. While the 114% appreciation is nice, the equity in the property is going to go to Fortress and the rest to Mr. Macklowe's other lenders.

Mr. Macklowe got greedy with his desire to purchase the seven Manhattan office building portfolio from the Blackstone Group. He put in less than 1% of his own money, and borrowed the rest on short term money. His assumption was that he could easily refinance the short term money after acquiring the property, but today's credit market felt differently as many of the banks were suffering from large write-downs on both their residential and commercial loan portfolios. What seemed as a safe bet in putting up his crown jewel as collateral is now in someone else's hands. So what can we learn about Mr. Macklowe's situation?

Don't stretch for a property. Evaluate every property on a stand alone basis. I know that real estate fortunes are framed by the Donald Trump's of the world, but leveraging everything for that big deal doesn't make sense. Also, leave emotion out of the buying equation.
Have a back up plan! Structuring the deal as Mr. Macklowe did is sometimes required especially when you have to put a deal together quickly. However, having your eggs in one basket isn't smart. Be prepared to bring partners into the deal if necessary. I know I said the "P" word, but the equity give up by bringing in a partner is less than the cost of a bank coming after you for their money.
Be aware of where you are in the Real Estate and Credit Cycles. If you are going to put your net worth at risk, make sure you are fully aware of where you are in both the real estate and credit cycles. Yes, that's right credit availability goes up and down just as the value of your building or house. Banks quickly adjust credit standards and availabilty overnight based on market developements. Usually the adjustments are to harsh and take time to settle out. Talk to commercial realtors, bankers and other real estate investor's before pulling the trigger.

So remember the words of my old boss: "Pigs get fed and Hog's get slaughtered" and you should be ok.

Are Commercial Loans the Next Subprime Mess??????

noreply@blogger.com (markstp) — Tue, 12 Feb 2008 16:35:00 +0000

No, the commercial world isn't coming to an end, but credit is tight these days - but not for everyone. A recent Federal Reserve poll of its member federally chartered banks showed that 80% of the banks responded that they have tighted lending standards on Commercial Loans!!!
Also, some big name property owners are experiencing problems refinancing debt obligations as they come due. Lastly, the commercial debt obligation securtiziation market has been shut down since December.

But there's hope. The problems are at the top of the property food chain, meaning that big isn't necessariliy good right now. This means that there is still a great number of options for the smaller real estate player to obtain financing for their projects. Remember, good deals get done!!

So here are some tips to remember when looking at properties as it relates to financing:

Bring a lender a property that cash flows today! If the property has good cash flow and can be verified, the better your chances your deal can get approved.
Be selective of your property type. Lenders are looking to protect their capital (i.e. reduce risk) so don't go walking into your lender's office with a gas station sitting on top of a super-fund site!!! Low vacancy apartment buildings, mixed use properites, and retail properties are better bets these days.
Leases, Leases, Leases. Look for properites with favorable lease terms. Those include, but not limited to, annual rent increases, triple net leases, and long term structures.

These three tips should increase your ability to get your property financed.

Oh, by the way. If you're wondering what the next big mess will be: Watch the Credit Swap Market and the Leverage Loan Market.

"Property Play - A Primer for Investors who are considering commercial real estate to build up their nest eggs" by Kemba J. Dunham

noreply@blogger.com (markstp) — Tue, 18 Dec 2007 15:37:00 +0000

In case you missed yesterday's Wall Street Journal article "Property Play - A primer for investors who are considering commercial real estate to build up their nest eggs", here is a review of this great introduction into real estate investing.

In this article, Kemba J. Dunham puts forth a basic outline to consider when looking at commercial real estate. Commercial real estate investments can range between retail strip malls, office buildings to real estate investment trusts (REITS), apartment buildings, and even five family residences. Unlike twenty years ago, financing is readily available for the purchase of commercial properites - making commerical real estate investing an option for the average American. However, as the article states commerical real estate investing is not for everyone and there are key considerations to follow.

First, Ms. Dunham states that every fledgling investor GET HELP. In every market there are commercial real estate brokers that can assist investors in selecting properties. They can add insight into local market rents, comparables, and even lenders. Other key advisors include a real estate attorney, and an accountant.

Second, the article points out several forms of ownership the investor should take title to the property. Direct Ownership or a third party vehicle, such as a Limited Liability Company or General Partnerships are the basic title considerations. Each form has its pluses and minuses. Direct Ownership is means that you take title to the property in your name. Some benefits include favorable tax consequences (consult a expereicned tax consultant), the ability to later conduct a 1031 exchange, and you're your own boss and don't have to share profits. The big downside to direct ownership is the liability - which is squarly on your shoulders.

Ms. Dunham provides a smart consideration to those investors that want to invest in commercial real estate but don't want the headaches of managing the property. In every market, there are capable property management companies that will manage the day to day on the property for a fee - usually 5% to 10% of the gross rent. The article suggest that "when hiring a management company, check out its references and see how well it is regarded locally".

Third, going alone scares many would-be investors, so partnering up with other investors makes sense. Partnering spreads the risk and lowers the personal contribution to get things going. However, an obvious drawback is the fact that you have to share the profits. The article suggests that those who don't want to go it alone find sponsors who buy commercial properties on behalf of small investors for a fee.

It goes on to suggests alternative forms of third party or sponsored ownership methods such as general partnerships, limited liability companies, or tenant-in-common arrangements (TIC). In a TIC arrangement each tenant owns a fractional share in the property. Limited liability companies offer the tax consequences involved in direct ownership while offering a direct liability shield against claims. There is a cost to set up a limited liability company or general partnership and a good commercial lawyer can assist in that process.

The last bit of advice in this great article focused on Triple Net-Lease Properties, which are properties that the tenant covers the utilities, taxes, and insurance in the rent. While the advantge to the owner is just collecting a check every month, the tenant would most likley require a long term lease as incentive to agree to those terms. As Ms. Dunham states in the article, "Because of the long leases, net lease properties can be very illiquid".

Overall, the article is a solid start for anyone looking to enter the commercial real estate market. The best piece of advice is get professional help - a commercial realtor, a real estate attorney, and an accountant.

How do I know I'm getting a good rate? Secrets your Banker doesn't want you to know.

noreply@blogger.com (markstp) — Tue, 11 Dec 2007 15:34:00 +0000

The most obvious way to know if your getting a good deal on your interest rate is to obtain at least three offers from Banks. The second way is not so obvious and is something that your Banker probably would prefer you not know. Here is the quick test.

1) Find out what index or source of funds your loan is based on. Most proposal letters will (should) tell your that your ten-year loan is based on the Ten-Year Treasury, the Ten-Year Federal Home Loan Bank, the Bank's own Cost of Funds, or LIBOR. You can check these base rates on the Internet or in newspapers such as the Wall Street Journal.

2) Take the stated interest rate found in your proposal letter and subtract the base rate determined in Step 1 above. For example, your proposal letter might state a 12% interest rate based on the Ten Year Treasury, which is at 9% (for example only). So 12% minus 9% equals 3% and that represents the Bank's revenue on the loan - revenue not profit. The spread between your stated rate and the base rate tells you a couple of things. First, the greater the spread the greater perceived risk by the Bank on your loan. Second, if you have an existing relationship with a bank, the spread can tell you if they are taking advantage of your company's business.

A fair spread between the index and the stated rate in the proposal letter is usually 2.00% -2.25%. This would represent a normal risk profile and most likely equates to a decent profit for the Bank. Remember, your Bank needs to make money as well and a bank that's not making money on your account will not be that helpful if things go bad.

Spreads in-excess of 2.25% could represent increased risk in the transaction or aggressive profit taking by your Bank. Risky transactions might include acquisition financing, shareholder buy-out that will affect the balance sheet, or a loan to fund net losses in the business. If any of those factors are involved then the Bank is just trying to risk adjust the rate they are charging for the new risk involved.

If your loan request is a normal term loan to buy a new machine, a line of credit to fund growth and your leverage isn't that high (below 3.5x), and your making money, then a spread above 2.5% means that your Bank is trying increase the profit on your relationship. I would speak to your lender and remind him or her of your relationship and that the pricing of the loan doesn't reflect that relationship. The banker might be so embarrassed that he or she might lower the spread to 2.00% or better.

So remember, an interest rate spread above 2.50% requires you to ask questions and either gain an understanding and respect for how your bank is looking at your loan, or come to the realization that your bank is gauging your cash flow through higher than necessary interest rates.

The Connecticut Development Authority ("CDA") Is Your Friend!!!

noreply@blogger.com (markstp) — Tue, 04 Dec 2007 03:13:00 +0000

The CDA is chalk full of good loan programs for Connecticut Companies. The CDA plays a very important role in the Connecticut banking landscape. Not only does it promote job growth or job retention in the State, it also provides a buffer with the wide swings in credit availability supplied by the Banks.

Now, you might think that with any quasi-government program comes with a mountain of red-tape - not with the CDA. The CDA has provided a streamlined, well publicised application process that reduces the time and frustrations felt by borrowers in the State. The application can be downloaded from its web site: CDA Application. But wait, there are very helpful CDA loan professionals ready to assist you with your situation. The CDA suggests calling the CDA loan offices prior to filling out the application (CDA Contact Info).

Before we go into some of the specific loan programs, here are some do's and don'ts with the CDA.

Which came first the chicken or the egg, or in this case the CDA or the Bank. Well, its a bit confusing with the CDA as well. The CDA's customers are the participating banks and lenders in the State, and not necessarily or directly the borrower. If you've been turned down by a bank or your astute enough to know that your loan request might cause your lender stress, then study the CDA programs and speak with a CDA loan officer. Get a green light (not a commitment, but an indication from the CDA that your request is in the realm of possibilities) from the CDA loan officer. Then start speaking with your existing lender or any prospective lenders about your loan request and the CDA. Having this knowledge would also so your bank that you mean business.
Have an understanding of the timing of the CDA and your lender. The CDA's Board of Directors meet once a month, usually on the 15th if that falls on a weekday. Applications usually have to be approved by the CDA management the last week of the prior month (at the latest). So if you have a tight time frame associated with your loan, then missing a key date might mean waiting another month before your get the funds.
Be confident on your projections in particular your employment projections. Remember, the CDA bases its support on your current and projected employment - among other things such as cash flow and collateral. Historically, the CDA has lent or guaranteed $10,000 to $20,000 per employee. The CDA will conduct annual audits on your employment levels, and any shortfalls that aren't easily explainable or extraordinary may result in penalties.
Provide the CDA the same information package that you provided your lender and remember your Lender has to fill out an application and provide certain information to the CDA as well. The lender has to fill out an application supporting its request for the CDA support and also has to provide the CDA its loan approval memo prior to the CDA going to its Board for final approval. So keeping tabs on your lender is important. Ask your loan officer if the CDA has the Bank's loan approval document. If he or she doesn't then you might be waiting another month.

The CDA is a great organization and its loan officers are experienced former bank lenders. So communication is important, and they are a good source of information and help. I'd like to now highlight one of the many lending programs offered by the CDA: The Participating Loan Program.

The Participating Loan Program essentially allows the CDA to participate with your lender in the loan structure provided to you - usually on the term or mortgage structure of your loan request. You continue to work with the lender and make your payments. The lender then distributes the CDA's piece of the payments to them. You are still working with one entity - your lender. There are no outside fees required as the CDA will participate with the lender's fees which you signed up for when you signed the commitment letter.

So its a marriage made in heaven - hopefully. The lender receives support to provide the needed loan to the customer (you), while not compromising its loan standards. The customer gets the money required to complete his or her business plan. The CDA provides support to the lender and thereby supports employment growth by the borrower. How does the CDA participation help the lender? The CDA participation is junior to the lender, which means that the CDA essentially has a second lien and the lender a first lien on the assets of the company.

If you find yourself looking for help to get the required money to grow your business and employee base, then the CDA is a great option to consider. If your banker doesn't mention it, then mention it to your banker. For more CDA programs, click here. Good Luck!!

How do I buy my competitor? Will my bank help me?

noreply@blogger.com (markstp) — Mon, 03 Dec 2007 17:49:00 +0000

Acquisition financing has always been challenging for banks. Why? Typically, the multiple being paid exceeds the tangible assets found on the acquired company's balance sheet. This collateral shortfall - as perceived by the bank - is a hurdle that most banks require an equity contribution to cover. The bank would also want you to have "skin" in the game by requiring an equity contributions. Equity contributions have hovered between 20% to 40% since 1996.

To figuire out how much your bank would lend on an acquistions, you must calculate the lendable value of the tangible assets, determine the debt service capability of the acquired company, and calculate the overall balance sheet and cash flow leverage at closing. Let's review each one seperately.

Lendable Value of the Tangible Assets:
Create a simple spreadsheet and put the assets in the first column, and the values found on the balance sheet of the acquired company. Typical assets include: Account receivable, Inventory (excluding Work-in-Process Inventory), Machinery and Equipment, and the Real Estate. Other assets such as customer lists, trade names are all assets, but not lendable assets from the bank's point of view.

In the next column put the following advance rate percentages next to each asset class: Account Receivable at 80%, Inventory at 50%, Machinery and Equipment at 50% of net book value, 70% of the orderly liquidation value, 90% of the forced liquidation value, and 80% on the value of any real estate. Total the net lendable value to determine the total lendable value of the acquired assets. Subtract 15% from the lendable value of the accounts recievable and inventory to account for working capital availibility that all banks will require.

Determine the Debt Service Capability of the Acquired Company's Cash Flow:
Start with the acquired company's EBITDA (Earnings before interest, taxes, depreciation, and amortization). Then adjust the cash flow from any expenses that are eliminated by the fact you are acquiring the company. These expenses might include: Prior owner's excess compensation and benefits, Miscellaneous professional fees, and rent. Once you've calculated the adjusted EBITDA, take the total lendable value of the tangible assets calculated above (minus the 15% working capital adjustment), and amortize that amount over seven year period to determine your annual principal payment. Most banks will set loan amortizations and maturities on acquisition debt to be between 5 to 7 years. In some cases, I've seen 10 years - when supported with an SBA guarantee or other credit enhancement. Apply a conservative interest rate on the debt to determine the total annual interest exepense. Add the total interest expense and principal payment to determine your total debt service.

Then take your total adjusted EBITDA and project your future capital expenditures. Subtract the capital expenditures from the EBTIDA to determine your free cash flow to service debt. Take that cash flow and divide into it the total annual principal and interest payments. This ratio cannot be lower than 1.20x. If it comes in below that figure, then more equity needs to go into the transaction. Siginificant cushion over the ratio might be a way to justify a lower equity contribution!

The last step is to determine the Day One balance sheet and cash flow leverage. Balance sheet leverage is determined by dividing your total liabilities by your total shareholders' equity. This ratio should be below 4.0x, although some bank's might be fine with 5.0x. Total calculate your cash flow leverage, divide your adjusted EBITDA by your total liabilities. This ratio should be below 5.0x and again some bank's might accept 6.0x.

Your banker will help you if you present to information calcluated above in the form of a formal presentation which would include projections. The quality of the presentation is a signal to the bank as to wether you are on the ball with this significant transaction. Listen to suggestions from your banker. Your banker might even suprise you and lend you 90% of the acquisition price, or he might say that this transaction would push your total debt over the risk tolerance of the bank. In that case you've got to go find a bank to help you complete the transaction.

What is a DSCR and Why does it have to be higher than 1.20x????

noreply@blogger.com (markstp) — Fri, 30 Nov 2007 20:57:00 +0000

Bankers speak their own language and expect us to understand it! One ratio that is very important to them when considering approving a loan is the Debt Service Coverage Ratio - or DSCR . This ratio simple measures the net cash flow of the real estate or business against the annual interest and principal payments on the debt (Debt Service).

Bankers love cushions - no, not the ones they sit on - but a buffer of net or free cash flow over and above the debt service requirements. This ratio begins to be acceptable to banks at 1.20x. So if you have annual debt service requirements of $100,000, then your net cash flow must be at or above $120,000 ($120,000/100,000 = 1.20x).

Certain banker's will go below 1.20x, but be prepared to see that increased risk in the interest rate charged on your loan. Look at it this way, your interest's and the bank's are together in this, because you would also want an acceptable cushion or protection against a loan default - especially if you signed a personal gurantee!

How close should I keep my banker about my business.

noreply@blogger.com (markstp) — Thu, 29 Nov 2007 15:57:00 +0000

To answer that question, it is helpful to understand what your loan officer has to deal with in his or her everyday life.

Did you know how many people look and touch your loan!
In most banks your loan officer has two to three direct and indirect bosses that are repsonsible for loan growth. They are also a watch dog charged to minimize losses on loans. Each boss has ever increasing span of control over loan officers and the sizez of the loan portfolio. Depending on the size of your loan or its current status (past due or current), changes - such as increases or extensions - to the loan agreement could go up to the highest levels of the bank! So for example, if you call your loan officer on Thursday to let him know that you can't meet payroll for your 50 employees on Friday, that problem would make its way up to the top levels of the bank. Well, we all know that scrap (put the right word in there) rolls down hill well the same applies to banks. Your loan officer will probably get a call from the EVP at the bank wanting to know what in blazes is going on with your company. Why, because this issue probably is sympton of something larger - perhaps a loan write-off. The decision/outcome on this problem will come from above, and a lot of pain and embarrsasment will flow down to the loan officer.

It doesn't stop there, there is another side of the bank - a side that you will never see, but has as much impact on your loan as your loan officer and his or her boss does. That dark, secret side of the bank is the credit administrative function of the bank. At least on a quarterly basis (and sometimes monthly depending upon the size and serious nature of the loan problem), your loan officer has to communicate to these unknown giants about the status of your company and the propsects of your ability to repay the loan.

Well, needless to say, I recommend meeting with your loan officer at least once a month alternating the location between the bank and your office. Its important that when visiting the bank you at least say hi to your loan officer's superiors. A human touch goest a long way in the event things go south. So think of your loan officer as the head bowling pin in bowling lane. He or she is the first pen, but there are nine other pins behind that make decisions on your loan. To bowl a strike it starts with the loan officer.

When you sit down with your banker tell him or her about what's going on in your business and industry. Note challenges and opportunities. Many bankers are interested to know that there might be future business down the road. Ask your banker if there are any new products to help improve your business: cash managemnet, foreign exchange, treasury, etc. These brief - limit then to an hour - help cement your relationship and buy you goodwill that you may need to cash in down the road. Remember, your bank is the largest vendor relationship your probably have, and while not an equity partner - they have the ability to make dramatic changes to how and who runs your business. A lunch here and there could make all the difference in the world.

I can't understand Bankers!!!! Here are 10 Ways to Creat A Smooth Loan Process.

noreply@blogger.com (markstp) — Tue, 27 Nov 2007 15:19:00 +0000

Does this look like you during your last loan negotiation? Well it doesn't have to be. It is true that bankers have their own language - a language that sounds greek to most of us. What is an LTV? What is LIBOR and what happend to the Prime Rate? What are negative and affirmative covenants? AGHHH! Wow, I just wanted to borrow money for five years to add a key new machine that will allow me to grow my business over 5% over the next few years. Is all of this worth it?

Be patient, here are a few helpful hints to smooth the process and get to that loan closing and the new machine you wanted.

Be fully prepared when you approach your bank for a loan. Here are things you should bring with you to give to your banker: A Cash Sources and Uses table (in other words what will the money be used for), A cash flow projection showing how the loan will be paid back, A copy of your financial statements and/or tax returns on your business for the past three years, and have three business references for your lender to call (this is not required if you already have a relationship with a Bank).
Be specific as to your timing expectations, but also be realistic. Banks - by design - typically do not act quickly. Don't walk into a bank and tell the banker that you need the money in two days - its just won't happen. To frame your timing expectations, communicate to the banker that you intend to present this opportunity to several banks, and that among other items meeting your timing is an important factor in your selection process.
Hire a lawyer that has completed several commercial finance transactions. I can't stress this enough. The protections provided to consumer borrowers doesn't flow to the commercial borrower - as the regulatory bodies assume that the borrower is sophisticated enough and has hired the appropriate counsel to enter into the transaction. Why a commercial finance attorney? Well they understand the ins and outs of a loan agreement that could literally be over 100 pages. If you aren't careful, you could easily be facing a not so nice consequences as a result of not having another set of eyes looking at your loan aggreement.
Know that everything is negotiable. It's not just price and term of the loan, but pretty much everthing in the loan agreement can be and must be negotiated up front. The bank is entitled to get its money back, however, setting and understanding the behavior in certain situations of both the borrower and the bank upfront is key. Nothing ever goes as planned. So default rates, grace periods, use of insurance proceeds, events of default are all things that should be hammered out prior to signing the loan agreement.
Control the transaction fees. It is completely appropriate to get caps on the bank's fee for legal counsel, and other miscellanous fees. Also, use the competitve nature of commercial lending to your benefit by entertaining multiple loan proposals.
Understand and control the "Conditions Precedent to Funding" language in your loan proposal. Bank issue proposal and commitment letters subject to certain conditions being met. This can range from obtaining a real estate appraisal to enviromental due diligence. These items could take weeks to a month to complete, and once completed each bank has internal specialist to review these reports which adds to the time. Use the proposal letter stage to eliminate any contingencies, that way you move quickly from a commitment letter to loan documents.
If things go sideways get the Bank's decision maker in the same room with you. Generally, loan officers report to superiors who have increasing loan authority to make changes or get the loan back on track. So if things go sideways and your tired of the daily "I'll have to get that approved by my boss", call the loan officer's boss and settle this quickly. The loan officer's boss want's the loan volume, and doesn't have a lot of time to deal with these situations prompting quick, decisive decisions to be made. The loan officer isn't intemidated because you helped him or her move the loan through the bank's beauracracy.
I know you have to run a business, but always put the ball back in the Bank's court. Set aside daily time to answer any questions the banker might have, and quickly get any additional reports, financial statements or other information back to the banker. Email is a great time saver here. There comes a point, however, whereby you get overwhelmed about the amount of additional pieces of information being requested. This is a sign that the bank isn't to sure it can get the loan done, and doesn't understand your business. If you get to this point then go to Point #7 for guidance.
Check out the Bank's reputation, by talking with other business owners. You might gain insight into a bank's behavior and quirks. Also, you make the final choice on the lender, but consult with your lawyer about the reputation of the bank you are selecting. There are banks out there that will submit a proposal letter to seal the business without regard to understanding the business. They think that they will figure it out during the loan process. Accepting a proposal letter from a bank like this guarantees a lengthy frustrating, costly loan process.
It's never to late to switch horses! The numbers are still in your favor, there are more banks chasing a low amount of loan requests. The worst thing you can do is to give into process by entering into a long term agreement (read partner) with a bank just because they have beaten you down. Despite time and costs involved in switching, the cost of entering a potentially bad relationship is more costly. Another bank can be brought in at any time, and would even make concessions on upfront costs to get your business.