Financing Focus

Money Talk

Borrowers may need a translator to understand today’s lending language.

Finding today’s best commercial real estate financing is a very different assignment than it was a decade ago. Savvy commercial real estate investors know that economic factors, such as jobs and geography, play a bigger role than in previous years. They also understand that, compared to the market before the 2008 economic downturn, the types of lenders interested in commercial real estate are very different, as are their underwriting requirements.

To secure the most advantageous financing, investors need to understand the most fundamental changes in capital markets. Borrowers are much more likely to find success when they approach lenders with a thoughtful financing strategy incorporated in a business plan that both meets expected standards and speaks lenders’ language.

Investors who do not have this expertise in-house may want to align with a capital markets expert who can help them navigate the sea of new underwriting and regulatory guidelines, diverse lenders, and financial structures that are available. Such experienced advisers can help borrowers organize information about the asset into a readable, digestible business plan that capital market players will quickly understand and respond to.

What Lenders Like

In considering loan underwriting trends, one four-letter word incorporates every lender’s first concern: jobs! The most appealing markets for lending are those where jobs are being created and are already plentiful, especially high-quality ones. Areas losing jobs are much less attractive for lenders of all types.

The “smile” of the United States — a crescent from Seattle through California across the Southwest, through the Southeast and back up the East Coast — holds the top choices for all lenders. If underwriters had their way, they’d only be placing loans in 24-hour gateway cities and primary markets, such as Seattle, San Francisco, Portland, Ore., Los Angeles, Phoenix, Dallas, Houston, Austin, Texas, San Antonio, Atlanta, Washington, D.C., area, Boston, and New York. Underwriting in these blue-chip markets should prove to be a little more flexible.

Of course, those same markets are coveted by most developers and investors. As a result, these markets have become very competitive and offer low yields through a higher basis, generating more risk. As a result, both borrowers and lenders are now looking harder into secondary cities and even creeping into tertiary cities seeking better risk-adjusted returns.

In second- and third-tier markets, the future of the asset must be stronger than ever to survive lender scrutiny. These less-competitive markets have historically produced more-volatile returns, since the loss of even one employer in a small market can be devastating to the local economy supporting the asset. Borrowers for these areas should expect to see more stringent underwriting standards.

The amount of equity required is another trend that can be challenging. Generally, long-term, fixed-rate senior financing on most assets will offer approximately 70 percent to 75 percent loan-to-value. For bridge financing, borrowers can expect to see a greater range of possible LTVs. For instance, interim debt could range from 50 percent to 65 percent LTV for construction or bridge financing for repurposing an existing building. Lenders have to be convinced that assets they underwrite can be credibly projected to be worth more than the debt at the end of investment term.

Possibly the most problematic step in today’s commercial real estate loan underwriting is projecting future interest rates in the current low-rate environment. Both lenders and borrowers know that interest rates can only go up. The question is, When and how fast will rates escalate? Borrowers can expect lenders to scrutinize the capitalization rates used in their projections in an effort to protect against possible refinance risk. Most lenders will model various scenarios of interest rates and cap rates and see how much stress is created by different outcomes.

Commercial real estate borrowers today also need to match the best type of lender to the assets they want to finance. For instance, pension funds with long-term liabilities to their clients are more concerned with financing class A assets that produce dependable cash flow for 30 years rather than purchase price. On the other hand, banks are better construction lenders and will offer variable rate financing, based on Libor with interest rates subject to change each quarter. For such long-term projects, lenders might also require borrowers to buy a collar or swap to effectively fix the variable rate of interest and mitigate future fluctuating rates. Finally, the growing number of private equity firms, real estate investment trusts, Wall Street funds, and structured finance lenders offer more choices to borrowers along with varying underwriting standards.

More than ever, the flexibility offered by a structured finance strategy can prove to be an optimal solution for investors seeking to fund projects valued at $15 million or more. Borrowers will most likely need to engage a knowledgeable adviser to pursue structured finance, but the added expertise should prove its worth. Such advisers should know which parties to source for different parts of the capital stack and also be able to create an auction environment, leveraging lender competition to borrowers’ advantage.

Capital markets speak a different language and look at deals with a different perspective. A good intermediary will be able to speak both languages — that of the borrower and lender — and negotiate favorable deals.

Douglas M. Thompson, CFA, is the president of VistaPointe Partners, which specializes in arranging debt and equity capital for commercial real estate. Contact him at


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