I heard of two deals recently that ended up going south after the lender apparently did not come through with the loan. Upon closer inspection, though, it was ignorance by the sponsor about how the lender would underwrite the deal, i.e. how they would value the asset and determine the LTV, for example. Or what they require of the sponsor. Or that they require (gasp!) a capital reserve at closing.
All of these materially alter the deal and need to be understood upfront.
To avoid these mistakes, it's imperative that you “interview” your commercial mortgage brokers so that you understand how they underwrite deals and they will require of you. Then you can incorporate those assumptions into your financial model (i.e. the SDA) and you won't be taken by surprise a few weeks before closing.
In my course The Ultimate Guide to Buying Apartment Buildings with Private” I have a list of 10 questions to ask your commercial mortgage brokers. What I wanted to do in this episode is actually interview a broker and ask them the 10 questions.
That way, you know the questions to ask and you'll also get an idea of what answers you can expect.
To help us with this exercise, I have on the call Ira Zlotowitz, founder and president of Eastern Union Funding and Shai Romirowsky, VP at Eastern Union Funding.
I picked them because they've looked at a few of my deals, they're a national lender, and have all kinds of products for every kind of situation. They also have two unique services: they will help you negotiate the best deal even if you have your own banking relationships, and they will help you raise equity – which is what we cover at the very end of the episode.
How to Connect with Shai Romirowsky
The best way to reach me is via email at sromirowsky at easternuc.com and my cell phone is 201.982.0283. I would look forward to hearing from you if we can help you fund your next deal!
More about Eastern Union Financial.
I've heard about several deals that ended up going south after the lender apparently did not come through with the loan. Upon closer inspection, though, it was ignorance by the sponsor about how the lender would underwrite the deal, i.e. how they would value the asset and determine the LTV, for example.
Therefore, I'd like to educate other syndicators out there about what questions to ask their lender to avoid this unfortunate situation. Since I have you on the line, I thought I'd let our listeners by a fly on the wall as I ask you some questions about how you would underwrite certain deals. Sound good?
Let's talk about loans for a stable property first (and then we'll talk about distressed assets later).
Stable are properties that cash flowing. Lenders have a concept called “seasoning”. The first month you achieve 90% occupancy, that is the first month of stabilization. Most lenders want to see the trailing 12 of stabilized expenses.
What are the basic terms I can expect for a typical loan? Specifically, what loan-to-value (LTV), interest rate, term, and amortization can I expect?
Interest rates are headed up. But historically speaking we're still in an incredible investing environment WRT interest-rates. A DSCR should be 1.25+, LTV 75% – interest rates are still high 4%, 30-year amortization.
Is the loan non-recourse or does it have to be personally guaranteed?
For first-time investors, expect some personal guarantees. But if the loan amounts are above $1M and you're not dealing with community banks, non-recourse loans are more common.
What are the costs of the loan? Specifically, what are the origination fees (typically 1% of the loan), the cost of 3rd party reports such as the appraisal, structural and environmental reports and legal fees?
Sometimes there's sticker shock for first-timers when they start the loan process. You normally you put a deposit down to order the appraisal ($2500 – $5000 depending on the deal, depending how quickly you need it) and other 3rd party reports. An average CRE transaction requires $4K – $10K for 4rd party reports, and legal prep docs.
The origination fee is typically 1%, and this is negotiable.
What size loans do you typically do, and in what areas?
Eastern Union does loans from $1M to $35M. We're dealing with syndicators, entrepreneurs, family offices. WRT asset class, we do a lot of work with MF and retail. We do loans nationwide. We're an east-coast based firm and we have a larger presence on the East coast.
What are the prepayment penalties if you decide to refinance or sell before the term of the loan?
Larger lenders tend to have yield maintenance or “defeasance” clause which make it harder to prepay early. Banks typically have a “step down” penalty. for example.
What about the sponsors? What do you look for in your underwriting there?
Many first-time borrowers overlook this element in the underwriting process. Lenders are a bit more cautious about what might be around the corner. They're putting more emphasis on strength of sponsorship.
They look at the level of experience: how many deals have you done? Do you own?
Also, financial sponsorship: net worth and liquidity post closing. They want to see a 10% post-closing liquidity cushion after closing. Net worth around the loan amount.
Co-sponsorship is where we underwrite more than one sponsor to satisfy these requirements.
Do you require any reserves or minimum account balances? Some lenders want you to deposit 6-9 months of interest payments into an escrow account and/or keep a minimum balance in the bank account. Some also want you to bank with them as a condition of the loan.
You should assume you'll need to carry an escrow for taxes and insurance. You also see reserves for turnover repairs, maintenance, and capital improvements.
These are all negotiable.
What is the typical time to close from the time I order the appraisal?
From the time you have a ratified contract, there is the due diligence period, in which you get your deposit back. But once that expires, there is a time to close. But you have gone “hard” on your deposit. It's difficult to close a loan in 30 days. Most lenders will tell you it will take 45-60 days from the time you order the appraisal. So it's really 90 days from the time you sign the contract.
What kind of loan products do you provide? Lenders could provide one or more of these loans: conventional, Fannie Mae/Freddie Mac loans, FHA/HUD loans, bridge loans, and/or construction loans. The more products a broker can provide, the better.
Let's talk about financing for distressed or value-add opportunities. What options are out there? What are the terms. And Once the asset is stabilized, what is the process of refinancing?
You can have a combination of a development/construction to conventional loans. Those are typically interest-only loans for 12-24 months. Then they roll into a permanent loan so you don't have to shop for a new loan.
Ira mentioned a couple unique services Eastern Union provides that I'd like to drill down. The first is the negotiation service. My understanding is that a sponsor can hire you to help him negotiate terms with a lender. Can you talk about that a bit more?
We realized that the biggest value we provide is the upfront work we do. We help you underwrite, put the package out there, and negotiate the best price. At that point, we step back as a broker and we'll work with your pre-existing relationships. We charge a flat $15,000 fee. It makes sense when you're doing larger transactions.
Ira also an equity raising service where Eastern would introduce a sponsor to pre-qualified, high-net-worth individuals. How does that work?
It's been a great value. What we do, in addition to our debt business, all day long they're cultivating relationships with high net worth individuals. We can introduce you to new potential investors. When you have a deal that's ready to go, we present it to our network,
That's also a flat fee service, its $6000 for a month's work of introductions as well as we also help you on the debt. Min. deal size should be in the $1M – $1.5M loan amount.
Do you have any final advice?
The earlier you can involve us, the better.