Updated: Aug 2
Imagine you’re a real estate investor who’s found your next big deal….You do some market research, make some calls, run your numbers, and submit an offer to the seller. You have some money saved as a down payment, and know that you’ll need to finance a portion of the purchase price with debt. Before you reach out to prospective lenders, it’s important to understand how they look at your particular deal, and how you can best position yourself to get an approval with the best possible terms. Before making a decision, the lender will want to have a solid understanding of you as the Sponsor, the business plan, the physical property itself, and the surrounding market, both micro and macro.
In this article, we highlight portions of a discussion with Brandon Goldschmidt, who has been extensively involved in originating and underwriting bridge, agency, and CMBS loans. His other experience includes providing commercial real estate valuation and advisory services for a global professional services firm.
Understanding the Sponsor
The Sponsor is responsible for paying back the loan and a good partnership is key to successfully executing the business plan and paying back the loan.
Lenders will want to examine the following attributes of a Sponsor when considering a bridge loan:
1. Financial Wherewithal – Net worth, liquidity, source of funds. Does the Sponsor have the financial ability to see the project through to completion if unforeseen circumstances pop up or the market changes?
2. Sponsor Credit - Credit score, bank references, and past ownership history. Does the Sponsor’s credit score indicate history of timely repayment? Does the Sponsor have bankruptcies or foreclosures in their past? If so, disclosure is mandatory upfront and a full explanation is critical to reassure the lender.
3. Sponsor’s Overall Real Estate Experience – What is the Sponsor’s overall real estate experience and how does it support this loan request? Have they successfully executed this strategy before? Does the Sponsor have experience with this particular property type?
4. Sponsor’s Knowledge of Specific Market – Is the Sponsor local to the market? Have they invested in this market before? Do they have ties to the market? Do they have a local partner?
While these are the key factors that lenders take into account when underwriting a Sponsor, it is important to keep in mind that deficiency in one area doesn’t always kill the deal, nor does strength in another make for automatic approval. It’s ultimately the entire picture that determines whether or not the loan will be issued.
It is important to keep in mind that deficiency in one area doesn’t always kill the deal, nor does strength in another make for automatic approval.
Understanding the Business Plan
A real estate investor seeking a bridge loan needs to provide a well thought-out and detailed, step-by-step plan of how the property is to go from current operations to future projected operations. This is in addition to how much money is needed and how it will be used. It is also important to provide market data in order to support different aspects of the plan.
Investors all look at deals differently, and therefore employ many different strategies when looking to add value. Here are a few very basic examples:
Acquire raw land and entitle property for a specific use and sell to a developer at a profit
Perform cosmetic and structural upgrades to the building to attract higher rental rates
Hire a new leasing team and develop a new leasing strategy to lease at a higher occupancy rate with higher rental rates
Increase income by instituting utility reimbursement plan (apartments) or a NNN lease
Restructure commercial properties, essentially managing the property more efficiently
Acquire a fully leased building that has below market rental rates in place, raise rents to market as leases expire
Acquire a property with impending vacancy, such as anchor tenant vacating, at a discount, and then invest in property improvements to lease that vacancy to new tenant
Here are some additional questions that will help the lender better understand the transaction and offer a more timely decision:
Does the Sponsor’s time frame to execute their business plan make sense and fit the proposed loan term?
What is net absorption in that submarket or how long have comparable properties taken to lease up?
Are future projected rents feasible? Is there market support? Comps? Broker Input?
How does stabilized occupancy projection compare to the market/submarket average?
How does it compare to its own occupancy history and that of competitive properties?
Understanding the Property and the Market
In order to provide the lender with an accurate picture of the property and understand the business plan, it is helpful to provide the following:
Age (year built/renovated)
Amenities (pool, gym, on-site management office, covered/garage parking, etc.), how does this compare to competitive properties in the market?
Is there any deferred maintenance?
Any new construction planned in the market? What are demand drivers? Is there a high rate of crime? These are key for multi-family properties
Environmental issues? Anything that might come up in an Environmental Report? These questions are especially important for older properties or properties near fuel facilities
Conclusion: A Decision in the Balance
A loan originator or loan officer is the first point of contact for the Sponsor and will perform the initial analysis of the deal before taking it to credit officers for approval. The more information they have upfront, the better their position for executing a more timely and accurate decision. Making a balanced decision here is key. The Sponsor needs to present themselves and the deal well by demonstrating knowledge and organization from the start. Lenders are not willing to wait until they have extended a loan to find out.
What is the future of risk assessment and underwriting?
As rates stay low and investor demand continues to increase, lenders need to be sure that they first underwrite the borrower correctly. This type of environment can lead to inexperienced borrowers overpaying or overextending themselves on deals. Also, with the changing landscape of office and retail properties, much of which was accelerated by Covid-19, the lender needs to be comfortable with future demand and existing supply for this particular asset type and how it fits into the local market.
Brandon says, "New technology and automation may help lenders in underwriting lower-leverage, plain vanilla deals in larger gateway cities with ample market data points, but I think the key word here is “help”, not “replace” traditional areas of credit analysis. The biggest advantages that I can see is that they can take some of the emotion out of parts of the analysis and shorten certain tasks. I don’t believe tech can fully replace the human decision element and experience in markets and property types."
Brandon Goldschmidt has been extensively involved in originating and underwriting bridge, agency, and CMBS loans. His other experience includes providing commercial real estate valuation and advisory services for a global professional services firm.