Today we are learning what are the pros and cons of each asset class and their loans. In this post we are covering office, retail, and warehouses. You will also learn some strategies for selling your property, as well as how long you should account for getting a commercial loan.
We are interviewing Billy Brown, the Vice President of Business Development for Alternative Capital Solutions, he has been in the mortgage lending industry for several years, and he focuses on working with real estate investors. He is a commercial investor himself, which is a very important quality for a lender to have.
Tell us a little bit about yourself
I am different than most any other lenders out there because I’m also an investor. I call myself an investor first, and a commercial lender second. Even though my day job is a commercial lender, we are active in the marketplace, and I courage investors themselves to go find lenders that actually are doing what they want to do because it makes a lot easier to communicate with those people versus just working with an order taker. My wife and I syndicated an 82 unit apartment complex in Lexington, Kentucky. We are within a couple days of closing our office space up in her hometown of Wisconsin. Then we’ve got our hooks into another property here and will hopefully close that by the end of the year if the sellers are open to our offer. In the syndication conference, I provided a bit of information reassessing equity, what I call lazy equity, in their portfolio, which we’ll talk about today, and reposition that to larger assets. I’m a generalist when it comes my personal investing, and as far as lending we help investors maximize ROI.
We can handle office, warehousing, self storage. We’re not pigeonholed into certain lending bucket. In my day job, we reverse engineered lending. Where normally you’d go to your bank guy and say “Hey, Mr. Banker, I’ve got this”. And they scratch their head and may do some pencil and they say “We can do this, or can’t do this”. And then you find out two weeks later, they can’t go do it. Then you have to start all over. We actually fully underwrite the loan request on the front end with our underwriters, and then we sit down and help strategize with our clients a way to maximize ROI, return on investment. And we like infinite, by the way. We love doing infinite, we then put that plan in place and we execute that plan. And then what we do is we fund that loan amongst our many lending partners, both in depository, institutional, non depository, etc.. It saves a lot of time because you know exactly what you’re looking for in the front end and the lender that raises their hand wants to go work with you, knows what you expect to what you’re looking for.
Let’s go over three or four different types of loan options and the pros and cons of each one of them, because it is important to know what the cons are so that all the investors can decide what is best for them and their business plan when they’re purchasing a property.
Absolutely. I love the way you phrase that as the pros and cons, because when people are loaning you money, that is cheaper than equity. So there’s always some kind of caveat there because they want to protect their investors when they go loan money. There’s a few cons on each one of these, and I’ll go over five options.
The first one is if you have a bunch of rentals, four, five, six of them, they’ve Fannie Mae, Freddie Mac lending on them and they’re getting a little frustrated with how more difficult is becoming to go get that sixth or seventh one. And they’re about to be what we call “Fannie and Freddie out”. They may see that the cash flows are good. There’s some equity in there that’s lazy, and they want to access that. And there’s a way to go do that. It’s called cross-collateralization. Just think of ease of use. You have four properties. You have one loan on each one of those properties. So you have to manage four mortgages, four insurance payments, four property managers, etc. What we then do is we take that into one loan and we can go up to 75% of the appraised value. And if it’s big enough, then we can do what’s called “non recourse lending”. If it’s not big enough, then we can go recourse lending.
Recourse is when you personally guarantee the loan. So if the loan goes bad, if the tenants move out, and you can’t subsidize yourself with your own cash flow, and the lender has to sell the property, if the loan is not made whole, they’ll come after you personally, and that’s never a good thing. Most of these smaller loans are recourse loans and, for the most part, right now we’re in a good economy. It’s OK because you’re feeling pretty good about your probability of keeping those tenants in there. Most professional investors go into non recourse lending and they do it because they’re not personally liable if that loan goes bad.
Now, the difference here is on the non-recourse side, you are the borrower. If something happens, then you’re basically not going to get the property back, and everyone’s made it square. And it’s easy to think that’s a great idea, not to worry about these things. Well, there are some caveats here. The catch on these loans is that they are typically more expensive because it takes more money to go through and securitize these loans. They’ll package them up, and sell them off to a hedge fund on Wall Street. So depending on your flavor of your positive or negative thinking of Wall Street, then you might not want that. There’s also prepayment penalties, and they’re usually pretty hefty.
How many years are there for prepayment penalties, are they for the entirety of the loan?
No, it’s not like multifamily, the prepayments are usually limited to the first three or five years. Usually the first two are pretty heavy in the 5% range, and then it drops down significantly after that. So by year three or four, you’re down to 1 or 2%.
When you have eight or ten, and even thirty or forty loans, and if you want to sell one of them, it is very difficult to release the collateral. It’s not impossible, but it is very difficult to do. The third one that most people are a little hesitant on is, because the lender wants to make sure that there’s no risk in that loan going bad, the only way to jump that loan is if you don’t pay taxes. So both your taxes and insurance are going to get escrowed. To me, I don’t care because that’s one less thing I have to be worried about, it’s all escrowed into one payment. Money goes in, they pay your thing for me, save me the profits, I’m good. It’s very easy. The good part of these things is that they are very low documents for 30 year amortized loans, and they’re very easy to do. So they really just revolve around the asset themselves and if you have enough properties in the same area, then many times you don’t need full appraisals. They’ll do a handful of full appraisals, they’ll do a handful of drive by appraisals and they’ll do a handful of desktop appraisals. And that’s how they determine the value.
If you want the most value, then you want to do full appraisals, assuming your properties are good. If the tenants have wrecked the properties a little bit, then maybe you don’t want them to go in the property. But we help you out there. These are very much investor friendly type loans. That would be a loan for the newer investor where they started accumulating a lot of properties and want to access that equity and go step up, so that equity is unrestricted and the can do anything they want to with it on the recourse or non recourse side of things. We call that a portfolio loan where they’re cross-collateralized. All it means is they’re tied into one loan across multiple different properties.
Office and Retail Loans
This one is one of those asset classes that’s under the radar and most people shy away from it, because the lending isn’t as great as the multi-family world. And that’s because the tenant determines what type of lending you can do, as well as the size of the loan. And the size of the loan matters, a $500,000 loan is actually harder to go get than a $5M loan. That’s a little flip on the the idea of starting small and moving up. It’s actually easier to get the bigger stuff. On the office, your tenants and the length of the lease will determine what type of loan you can get.
If you have a single tenant, let’s say it’s a barbershop, and they signed a one year lease, it’s going to be very difficult to get lending for you. That’s would be more of a depository banking type of loan. It’s going be very low loan to value and they’re going to have some restrictions on the cash flow. They’re going to want to get paid first (what’s called Treasury Management) before you can go release the rest, and they will have some restrictions on what types of reserves you’re going to get. The one we’re buying, is a NNN lease with a larger national financial institution where the tenant pays the taxes, insurance, all maintenance, etc, and they signed a long lease. Then you can get better terms. And most of the time it’s going to be a 20 year amortized loan, with lower interest rates. Anywhere from a prime minus rate. And if it’s a large enough deal, you can actually get non recourse.
If your listeners are interested in office, do a lot of research because the lease matters, the tenant matters a lot in this case. The cool thing about offices and warehouses is that the leases can be tweaked so much so that, if there’s a bill back for what’s called the common area maintenance (CAM), you can increase net operating income (NOI), which makes the property more valuable. And that can be just done inside the lease. If you have a really good leasing manager, that can really help you out and create more cash flow. I’ve a friend here, Tyler Colwell, that wrote a book on leasing for both the owner occupied deal, and for an investor, on what to look for. I read the book before I bought this office complex, and learned a lot. Do your research. As an investor, if you have a NNN lease on an office, it’s like an ATM. You’re going to probably not get as much cash flow from it because the longer the lease, the larger the institution buying it, the lower your cap rate, the lower your cash flow. So you’re not going to be balling on cash, but it’s a steady stream.
The strength of the tenant determines the strength of the loan. I’ll caveat that by saying that the borrower has to have some kind of clout behind it and some financial wherewithal. If you’re newer, partner with someone that is more experienced. Despite what we’re told in America that you should do everything on your own, it’s actually better to partner up with someone that has more experience, in order to learn and have a little better understanding of how things work when, not if, when things go wrong. I’m going through this right now with the office deal, it was literally a straightforward deal, and even the straightforward deals were not straightforward.
Your own loan that you were doing yourself, was not straightforward?
Not at all. Because things come out, like environmental issues, etc. That’s a whole other podcast “The 25 Ways Billy Screwed Up His Own Deal”. I didn’t really screw it up, I just made it more difficult than it should have been. I’m actually getting a really good deal on it. There’s no perfect transaction. There’s no perfect loan. There’s no perfect loan process. You have to have a team in your corner that can help guide you and help steer the ship as you’re going through turbulent waters. The right lender can actually help you from making mistakes.
When we talk about assumability on those loans, and usually assumability comes on the non-recourse side, and that would be a higher level conversation as far as strategies. But assumability is an exit strategy. There are some other unique lending opportunities, where instead of buying the property, you buy the LLC, and instead of assuming the loan, you assume the LLC. If you’re in a high tax state like California, New York, Illinois, there are some hefty transfer taxes, that’s a strategy for that as well, if you have a single purpose entity.
And they still can’t get a second loan on top of that?
That is correct. You can’t do any kind of second loans, most of the time, on those types of lending. So you have to be aware of the deal and how it cash flows.
It’s important to be aware that the type of asset that you’re buying determines your loan, as does the length of the contract. Give yourself plenty of time when you go do these deals, don’t put 30 day close, they aren’t going to happen. Because all of these things have to have appraisals. And every commercial appraisal has to have an appraisal review. The appraisal process is three weeks, and most lenders do not order the appraisal until it’s fully underwritten. That can be a little bit of time as well. Be be cautious there.
Warehouses are probably the next best tenant because these guys typically stick around once they put in their $100,000-$200,000 equipment and they bolt it to the floor. Most of time they don’t leave. They’ll sign leases and they just keep on staying there because these guys like to work their hands, they’re typically not business people so much and they just don’t want to move. It’s a pain in the rear to go get these things off the ground, bolted, and go find another place, especially warehouses. The flex space and warehouse space is not something that they are really building much anymore. And if you buy some existing warehouse, that is less than what it costs to build new, then you’ve a winner. Much like office, the strength of the tenant determines the strength of the loan or some kind of gross modified lease. But it works out to where you have a little bit higher cash flow if you have some better tenants. If you have some midsize businesses like an auto body shop, lawn and garden repair, shipping and receiving, they will typically be a little bit more conservative on their lending because they want to see the strength of the tenant. And a lot of times these lenders actually ask for the financials of the tenant.
So be prepared, especially if you have a new tenant, someone that has a newer business, they may get upset about it and say “What do you mean my financials?”. But we need to see some strength in your financials to be able to lease to you, because the last thing I want to do is to sign a three year lease, and come to find out that you’re don’t have positive cash flow. Then I have to evict you. And it costs money, and wastes time.
You can bundle the office, warehouse and retail, in general, in the same bucket as far as your lending options. Because it’s all determined by the strength of the tenant. For newer investors, they’re going to be a lot more conservative, and have a lower loan to value, versus the NNN larger corporate tenants. I always have my investor hat on when I’m talking to groups investors, because I am one. I always look at the cash flow. If you get a good deal, it’s all on the buy. The lending becomes much easier. So you have to negotiate the right way.
There are bankers and lenders out there that are also investors. You just have to interview them. I’m just out there more because we have a higher goal for ourselves on what we want to do. I just have the gift of finding lending and putting things together, and that’s my strategy, which also makes me a great investor.