Real Estate commercial financing explained


If you want to skip this and just go directly to an explanation on how income producing properties are analyzed in real life go to this financing example.

Let me make it clear that if you have any ideas about making yourself an instant millionaire by doing some sort of no-money down scheme, you are coming to the wrong place. I am not interested in selling you some book, course or have you attend one of my seminars. I am not after your money.

Obtaining owner financing, where you will not have to put any money of your own, and where the seller keeps a second mortgage on the property sold is very rare. I have personally handled hundreds of real state files, and I have not seen any deal structured like that. While working on the platform as the first contact for customers looking for financing, I saw only one proposal that was structured with the current owner carrying a second (out of approximately thirty requests).

As a potential purchaser who knows of the rarity of such a financing arrangement, wouldn't your warning detectors go off if the seller is very willing to accept such a proposal? An owner that is selling his property with seller financing is probably out to get himself a better price for the property than the true market value. In the case that I mentioned before the owner had the property listed with a Real Estate Broker for $340,000 with no takers. In fact, the broker had requested that the asking price be reduced to $320,000. Instead he brought us an acquaintance of his to qualify for a first mortgage of $255,000 while the seller kept an $85,000 second mortgage.

Banks as a rule do not lend based on collateral. Your apartment building, Commercial Warehouse, Rental House etc. has to cash flow. Credit History does matter. In the case referenced above, the Bank was willing to bend its credit policy by allowing a debt service ratio of 1:04X instead of the minimum 1:20X to please the seller, and convince him to bring his own $1,000,000 facility to the Bank. However, the borrower had very limited credit with two (2) derogatory items (He was turned down).

Self-made millionaires giving those no money down seminars usually forget to mention that there are a lot of other expenses related to owning an income producing property. (These expenses usually run around thirty (30%) percent of potential gross income). Just this Sunday I was watching TV when I saw one of those infomercials when one of them claimed that he had bought a property with a loan where his P&I payments were $375 and his rent was $450 giving him positive cash flow. I had to wonder how the insurance, taxes and utilities were going to be paid.

While I am bad mouthing the entire no-money down industry, let me take this opportunity to complain about those pushing for people to become investors in secondary market mortgage notes. Apparently, the latest version of this "scam" is marketing their "no-money down system" in coalition with buying 2nd mortgage notes at a discount. I just read today something this guy wrote about buying a house with no-money down using a mortgage note from a third party and having a simultaneous closing with money going all over the place. I am not saying something like that is not possible, all that I am saying is that it is highly improbable that anyone can pull it off since his scenario requires that:

a) Someone sells a perfectly good note that is paying a perfectly good monthly income for a 50% discount.

b) That someone is willing to take a note that was just purchased at a 50% discount and that is not even secured by the house they are selling at full value.

Stuff like that makes me upset since it is not at all probable and those people selling books, courses or seminars make it seem like something easy too do.

If it were that easy to make money, I would be doing it. The fact is that opportunities are scarce, and the field is crowded. I used to get all the calls asking for the OREO (Other Real Estate Owned) Bank list forwarded to my extension. The times were Banks gave stuff away are long gone, believe it or not Banks have heard of Real Estate Brokers too.

The following is a list of requirements that are common to most small Banks when it comes to financing Income Producing Properties (Shopping Strips, Apartment Buildings, and Commercial Warehouses):

1) Banks will usually not finance more than 75% of the appraised value of the property.

2) Properties must show sufficient debt-repayment ability by way of a ratio of 1:20X or higher. (See more about this in the next section).

3) In case that the property financed is occupied by a sole tenant (commercial warehouse) the lender might want to take a look at the financial strength of the tenant.

4) You will need to provide an updated rent roll to the lender, which might require the same every year.

5) If the property is not residential in nature, the lender might require an environmental audit (phase-I) to find out any possible contamination of the site.

Now let me show you how properties are financed in the real world just take a look at this financing deal.

For additional information about commercial real estate financing, you can read this book Commercial Mortgages 101: Everything You Need to Know to Create a Winning Loan Request Package


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