When I first started working with Commercial Mortgages about 10 years ago, I had a hard time wrapping my head around what went into putting one of these deals together. Each deal is truly unique and I soon found can have many moving parts. In order to get a better understanding of what I was doing, I needed to put in place a process, or standardized approach that I could follow on all my deals. After a while, I found what works for me and wanted to share this approach. I found that there are several key factors that contribute to a typical deal and how addressing these factors can help you to “See the Deal”.
Since most, if not all commercial mortgages are paper-based and there really isn’t a web-based system like filogix that you can use to enter information into in order to produce a clear picture, the story or summary that is prepared for a commercial deal is very important. This summary gives me a good overview and allows me to “See the Deal” so that when I’m speaking to a prospective lender, colleague or drafting a quick email, I can highlight the critical points fairly quickly and concisely.
One way to “See the Deal” is to use the 3-legged stool or a 3-point triangle like the one at the beginning of this article. Basically, the main points or factors that I work with and focus on in my approach are:
1) The Covenant
2) The Income
3) The Real Estate
The idea is to analyze each point and gather the necessary details for each in order to determine whether that point is weak or strong. What documentation do you need to assess each point? Also, what or where are the risks associated with each point and if necessary how can these risks be mitigated? How can you best sum up each point?
When looking at the ‘Covenant’, consider this;
- What is the Borrower’s net worth? With commercial mortgage financing, the Borrower’s income is not that important since we don’t rely on their income to pay the mortgage – the property’s rent does. The Borrower’s net worth is more important.
- Is the Borrower’s net worth all comprised of real estate or is it well diversified? How much in liquid assets do they have?
- If they needed to inject funds into the property for emergency repairs (ie. Roof or HVAC system needs a replacement immediately) or they need to cover the mortgage payment from their own resources due to unexpected or chronic vacancy, would they have the funds available?
- How’s their personal credit? Are their taxes current? Do they have any other sources of income?
When looking at the ‘Income’, we typically consider what determines and what can affect the property’s rent and this can include;
- Cash flow. What does this look like? How much rent does the property generate? What is the likelihood that it will continue?
- Net Operating Income (NOI), which is Income minus Expenses. The NOI is important since we use the NOI to calculate the two critical ratios used in commercial lending – the Loan To Value (LTV) and the Debt Coverage Ratio (DCR)
- What are the leases like? Short term, long term? Do the tenants pay for any expenses such as taxes, utilities, insurance or maintenance? Ie. Are the leases Gross, Semi-Gross or Triple Net?
- Do all the leases come due at the same time, in the same year or are they staggered over several years (this is known as Rollover Risk)?
- Are the rents below, at or above market rents? How do they compare to similar properties? Are there yearly increases (step-ups)?
- What type of tenants are they? Weak or strong? For example, Tim Horton’s is a great tenant; stand-alone restaurants, not so great. What’s the history of the tenancy?
- What is the vacancy like and how has it been historically?
- Does the client have a properly prepared Rent Roll?
Finally, when looking at the ‘Real Estate’ (which IS the lender’s main security) some of the points to consider are:
- What type of property is it? Conventional, unconventional or special use? Can it be easily converted for other uses?
- Where is it located? Is it urban or rural? Is it located in an area with other similar properties? Or does it stand out?
- What is the property worth? How does the value compare to similar properties? Do we have an appraisal?
- What is the property’s condition? Are there any major repairs or upgrades that are needed in the short or medium term?
- How old is the property? Is the property too old to repair? Do we have a Building Condition Report (BCA)? Will we need one?
- Are there any sources of environmental impact on or near the property? What is located across, next to or upgrade to the property? Do we have an Environmental Site Assessment (ESA)? Will we need one?
I’ve ended each section with Etc because by no means did I include all of the possible things to consider or questions to ask.
By being able to “See the Deal” a commercial broker will be able to discuss the file clearly. Discuss the strengths and weaknesses. Discuss the risk factors and what can be done to mitigate those factors. This will also help in gathering the necessary documentation and identify what will be required in order to proceed, quickly and efficiently.
The benefits to developing an approach similar to this are many. This allows for a more streamlined and standardized process which will also make a broker’s life easier when putting the deal together and making the process as painless as possible for the client.
It also instills confidence in the lenders you will be marketing the deal to since it shows some thought and insight into your underwriting. Also, one factor I know is critical with most lenders, is to have some conviction and to believe in the deal; when submitting a file for review I find that really standing behind the deal, “…I recommend the deal based on…..” and list your thoughts goes along way versus saying, “….I have a deal….what do you think……?”. “Seeing the Deal”, makes it easier to stand behind the deal and express why. This will only strengthen your relationship with your lenders.
In the end, this will result in a quicker turn around and the ability to get a better deal for your client.
Ermanno Tasciotti | January 2018