Financing Focus

Follow the Money

What are today’s most financeable deals?

If you are like many commercial real estate brokers these days, 85 percent of your transactions are lease deals and only 15 percent are sales. Purchase transactions are often a frustrating secondary source of income, as closings are harder to predict, due to the additional components involved, such as value, environmental, title, and, of course, financing.

However, this situation may soon change. The next 12 to 18 months will likely be one of the most active periods for owner-occupied sales transactions since the post-recovery period following the savings and loan crisis of the late 1980s. That’s good news for commercial real estate practitioners, especially those who frequently handle deals under $5 million.

Why the Uptick?

Several market forces currently at work foretell a stronger lending environment in the next 12 to 18 months. The secondary market where commercial mortgages and Small Business Administration loans are sold should remain strong. The commercial mortgage-backed securities market will continue to experience rocky but brisk growth. Nearly $41.1 billion in CMBS was issued in the first half of 2013, according to Commercial Real Estate Direct, 2.5 times the amount during 1H12. Despite a midyear slowdown, experts forecast around $65 billion in CMBS by yearend, almost twice last year’s total. It is widely assumed that CMBS issuance will eventually match prerecession levels of $400 billion annually.

Increasing activity in the secondary market means easier credit for borrowers, and more liquidity for banks and the overall market. Banks can free up loans on their balance sheets, enabling them to re-lend capital that was previously locked up. Credit parameters will continue to become more flexible and loan terms will get better for borrowers. Lenders will compete harder to win deals: This is good for brokers and borrowers.

Small businesses — the lifeblood of the U.S. economy — are becoming more bankable from a traditional underwriting perspective. They have paid down debt and have more liquidity to use as the equity injection on property purchases. Increasing revenues make them more attractive to lenders. Many companies have spent the last five years cutting costs so their level of profit may even be higher than in the past.

Currently, 90 percent financing is widely available with SBA loan programs. Borrowers that have profitable businesses won’t have to tie up as much capital in their commercial real estate, while still putting themselves in a position to build equity and long-term wealth. Often, these loans do not take much more time than a conventional loan and they are fully amortizing (up to 25 years), with no balloons or call features. These loans may also include money for improvements and equipment, as well as working capital, so borrowers can satisfy more than just the real estate need of the business.

While interest rates are ticking up, they will likely stay at relatively lower levels as compared with prerecession rates. However, this should motivate small-business owners to act soon since rates will eventually increase to more normal, higher levels.

With the general economy continuing to recover, small-business owners’ confidence should grow with their sales levels. Investing in hard assets such as commercial real estate will assist them in gaining control of their business’s occupancy costs. Since we are at some of the lowest real estate value levels in years, there’s a window of opportunity to purchase real estate at this time, as these values will start to rise as the economy continues to improve. In addition, inflation may be around the corner, so having control of their real estate expense gives small-business owners much greater control over expenses going forward.

Targeting Ready Buyers

Small-business owners fit the profile for one of the most financeable deal types today: owner-occupied, general-purpose properties in office, retail, or industrial; with loan amounts from $500,000 to $3 million. This target is the most attractive asset class for lenders. Banks are eager to lend in this asset class and within these targeted loan amounts. Commercial brokers and sales agents who focus on this target market should increase their sales commissions.

What not to focus on are commercial investment property loans with no national tenants, shorter term leases, loan amounts less than $3 million, in areas with populations less than 50,000. This continues to be the no man’s land in commercial real estate financing. Many of these loan requests have sat dormant since 2007. It’s unfortunate for the owners, but the market reality dictates lending options. You may find a local bank or two that will be interested in a stronger version of the investment loan that is described above, but you are not going to have a robust pool of lenders to work with to ensure a successful closing.

Focusing on what is easy to finance puts commercial practitioners in the position to make a higher percentage of overall commission income for the foreseeable future and earn a piece of the recovery.

Jeff Rauth is vice president and business development officer for Titan Bank, a national PLP, SBA lender. Contact him at jrauth@titanbank.com.

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