Be prepared, and demonstrate your financial knowledge when seeking a commercial real estate loan.
By Robert Owens
Small business owners in the process of looking for a new business location likely find themselves in one of three typical scenarios: 1) their business has outgrown its current space, and they’re looking to lease a larger space, 2) they want to build an ideal space because they’ve been unable to find a suitable existing one to lease, 3) they want to acquire the building where their business currently is located.
The latter two scenarios lead to either acquisition or development of property. Assuming the loan on a new space or building will allow a business owner to invest equity into the building, rather than just paying rent to someone else. When you’re thinking about acquiring an existing property or building a facility, keep in mind these different situations will affect the financing process, because construction loans are not the same as loans for acquiring existing property.
Your commercial lender probably will not be involved in choosing what method of expansion is best for your business. Business owners need to make that decision and be prepared with the information about whether they are seeking financing for an acquisition or construction, the type of building and amount of space and any other data related to the space’s geography and location.
Most people have probably been through the financing process either through a personal or home mortgage loan, or for various loans as a business owner. But the lending process for commercial real estate can seem like a totally different playing field, even though there are many tenets that hold true for any type of financing. There are some simple, general hallmarks to keep in mind when applying for a commercial real estate loan.
Preparation Is a Must Just as you expect your commercial lender to be knowledgeable, prepared and professional, your banker will expect the same of you. Prepare a set of materials that includes a written request outlining your proposal for financing, historical financials of your business, company projections, tax returns, personal financials and any other information relevant to the business and ownership structure.
Most often, the business owner personally buys commercial real estate space and leases it back to the company. This is to avoid putting additional debt on a small business and takes into consideration certain tax-advantage scenarios for the business owner. So, part of your preparation needs to include clearly outlining the business and real estate ownership structure.
Provide Solid References Typically, your commercial lender will want to call upon references who can speak to your integrity and business acumen, and also the structure and solvency of the business itself. Examples of some possible sources could include your accountant, attorney and real estate broker or general contractor, depending on whether you’re acquiring or building. Consult potential references before giving out their contact information to make sure they have background information on the situation and are comfortable with being contacted. Have a Sound Plan for Debt Service In a real estate deal, whether you’re acquiring or developing, your loan is paid back through rent you collect from tenants. In an owner-occupied situation, your debt service will also go hand-in-hand with your closely held business cash flow. Your real estate investment’s net income is rent, less expenses, such as insurance, taxes, utilities and repairs on the building. This net income minus expenses is what’s available to pay back your loan. You’ll need to ask yourself whether your business can afford any increase in market rent or loan payments.
From a debt service standpoint, your net operating income needs to be a 10 to 20 percent margin above the debt service requirement. Typical amortization with commercial real estate loans is 15 to 20 years. However, don’t expect a loan commitment from your commercial lender to be longer than five to seven years. Be Knowledgeable About Financials You should be aware of costs associated with the acquisition or development of commercial real estate and how you plan to pay back a loan in order to assess whether real estate acquisition makes sense given your cash flow situation.
Equity is important because it's a measure of how much you've invested in the business. Be realistic about how much you expect to borrow based on how much equity is in the property. Equity put into the business allows your banker to consider and allow for the fluctuation in value over the life of the loan.
When discussing financing with your lender, be open to new ideas and willing to at least listen, even if you don't initially agree. Don’t give up or get discouraged. You’ll have a much easier time and smoother process if you are a knowledgeable business owner who is able to convey and communicate that knowledge to your banker.
Robert Owens is senior vice president of Enterprise Bank & Trust in Overland Park. He can be reached at (913) 663-5525 or .
