| What type of Commercial loan to apply Posted by: May Tess Apr 15 2004, 08:53 PM A friend is partnering with us to purchase a commercial property. We had decided to form an LLC to purchase the property. We are overwhelmed by all the different types of loan out there. This building is currently a hair salon. We are going to remodel it into an office, which then our friend – the partner would move his business office there and lease the office from the LLC. Our plan is to then expand the building to add more office space then lease out to other businesses. We may need additional financing then, which is shortly after we purchase the building. Considering the news reporting that interest rates are going up, what type of loan do you suggest we take? Posted by: loanuniverse Apr 16 2004, 08:32 AM May Tess: Do not be overwhelmed by all the different types of loans. In the end financing options are easy to sort out by using the “present value of money” concept. That is, you can reduce the different interest rates and fees to a common value by discounting them to the present and that way you can compare apples to apples. I have done this for a few people already and will not mind giving you feedback on the deals that are offered to you once you have concrete offers in hand. In addition to the rate and fees, there are other matters that have to be taken into account when deciding between possible loan options. In no particular order, they are as follows: Prepayment penalty I dislike the idea of having a prepayment clause in a real estate loan. However, this is more and more common amongst lenders. Also, this is something that is more prevalent in small size relationships. If you can, negotiate this away. Amortization and Maturity The way this works is that the longer the amortization the lower the payment as the principal is divided into increasingly smaller chunks as the period of years increases. Twenty years is pretty standard with twenty-five being something that can be obtained relatively easy. Thirty years is rare in commercial properties, but I have seen it in rare occasions. Usually the lender will give you a maturity that is smaller than the amortization, this allows the lender to revisit the loan and reprice the rate to the prevailing market rates. In essence, there will be a balloon payment at the end of the term. The most common loan structures that I have seen for commercial real estate are: —A five year loan with a twenty year amortization. —A five year loan with a twenty-five year amortization. —A fully amortizing fifteen-year loan with a fifteen-year amortization { this is a loan structure being offered by a lot of lenders for the purpose of helping small businesses buy property for their operations. In my market, there are three banks offering this product with rates ranging from 6.7% to 6.9%. While the rate might be higher than the other two options, you get the benefit of fixing it for fifteen years, which is not bad. } Although those structures are common, there are hundreds of possible combinations that can be gotten. Repricing Another thing that I think will be useful is that if you are offered a loan with a five year maturity that you request one with maybe a ten year maturity, but let the lender change the rate at the end of the fifth year to the prevailing market rate. This way, you avoid having to look around for financing in five years. As you will soon find out, the fees associated with the commercial loan closing can be quite hefty. This will be easier to understand with an example. Lets say that the loan is for $200,000 and you are able to negotiate a five-year loan with a fixed rate of 6% for five years with a twenty-five year amortization. You can then ask the lender to give you a ten-year loan with the rate fixed for the first five-years, but will allow them to reprice it at the end of the five years to the prevailing market rate. This rate is determined by using a base rate {prime or 5 year T-Bill} and adding a premium. You could agree that the rate will be repriced at prime plus 2%. If prime is still 4% in five years then you still pay 6% for the last five years. If prime is 5% then you pay 7% for the last five years. I could go on and on about things that you should watch out for, and how to negotiate, but if you look around the site you will see answers to similar questions that I have given to other people. I think is best that I address your question ” Considering the news reporting that interest rates are going up, what type of loan do you suggest we take?” My answer: I suggest that you take the best possible loan that you can get. This can only be answered by shopping around. All markets are different and there might be one or two lenders in your area that are being aggressive as to the way that they are pricing their loans. The best way to approach this would be to get in touch with three lenders and have them give you an offer. The consultation will be free and a good lender will not require a fee until they issue a binding commitment letter. You are right about interest rates possibly going up. It wasn’t too long ago when I was underwriting these loans with 9% or 10% rates. Eventually, I believe that rates might drift up a little. I just don’t know when that would happen. If I did, I would be a millionaire. Knowing that rates are low, there is a lot of value in locking in the financing for as long a period of time as possible. That is something that you have to take into consideration when you compare the offers. The best loan would be the one with the longest maturity, the longest amortization, the lowest rate, the lowest fees, and no prepayment penalty. Unfortunately, I don’t think that there will be one of them that has all the characteristicts. Therefore, you can only choose when you have the choices in front of you. Well, I think I rambled enough…. But I hope this helps. Posted by: May Tess Apr 16 2004, 09:37 AM Thank you for the prompt reply. You gave me good questions to ask the lenders and items to negotiate with them. The offers I received so far are (for a $337500 loan): 1. 5 year Term, 240 months amort., fixed at 6.5%. Origination fee $4217.81 2. 5 year Term, 240 month amort., rate is Prime +1%, Origination fee $4217.81 Based on what you wrote, I should try to get them to lenghten the term, possibly to 10 years, and/or lenghten the amort. period. Is it true that bad credit doesn’t matter much if we borrow through the LLC? Our partner has a very bad credit, that’s why he got us into the deal to help him get the loan. Posted by: loanuniverse Apr 16 2004, 10:36 AM A couple of questions? 1. Is the second option a floating rate? 2. Are the two options from the same lender? 3. Is the origination fee inclusive of appraisal and closing fees or is it just the lender’s fee? { If it is the later, then it might be a bit much } Assuming that the second option has a fixed rate, it is definitely a better deal since prime is 4% and the rate would be 5%. A 5% rate is very competitive in today’s market. A 6.5% rate for five years assuming that debt repayment and loan-to-value are there is not so good. I would try to get a couple of things from them in negotiation: 1- A longer maturity. Proposing a ten-year maturity with a repricing at the end of the fifth year to the prevailing prime plus 1% and fixed at that rate for the last five years will be for your benefit since you will be saving the fees for the new loan five years from now. 2- A longer amortization. Changing it to 25 years will decrease your payments and improve your cash flow. Regarding: “Is it true that bad credit doesn’t matter much if we borrow through the LLC? Our partner has a very bad credit, that’s why he got us into the deal to help him get the loan.” Bad credit does matter…. In this case not only are you looking at this individual’s credit to underwrite the loan, but because the prospective tenant is owned by him, that should be taken into account by the credit analyst when underwriting the loan. If this loan was on my desk, I would ask for financial information on the tenant. Depending on how bad the credit is, this might not be a deal killer. Good luck |
