Potential clients often ask me, “What is the interest rate on a commercial real estate loan?” The short answer would be, “It depends.” I do not actually answer the question in that manner but instead start the conversation by asking the client several questions about their situation and the specific type of property they are considering. Before I can provide guidance to the client on loan terms, I need to gather information.
Commercial banks, credit unions, life insurance companies, debt funds and CMBS lenders are all potential sources of debt capital for single tenant net leased (STNL) and multi-tenant net leased (MTNL) properties. The choices of which type of lender and the specific lender for a particular property are heavily influenced by
(a) the buyer client’s situation/financing requirements and
(b) the characteristics of the property.
Questions regarding the buyer situation and requirements for debt capital include:
- How much cash is available through 1031 exchange or other sources to fund the down payment and closing costs? The amount of cash to invest relative to the purchase price determines the Loan-To-Cost (LTC) ratio. This is an especially important metric for lenders.
- How long does the buyer expect to own the acquired property?
- What amount of net cash flow does the buyer desire from the property? The answer to this question helps to determine the loan amortization schedule that is needed to achieve the cash flow target.
- Is it important to the buyer to have flexibility to pre-pay the loan with little or no penalty?
- Does it matter to the buyer whether the loan will be full recourse, partial recourse, or non-recourse?
- What is the net worth and liquidity of the buyer? Lenders generally want to see buyer net worth of at least the requested loan amount. Buyer should generally have at least 10% of the loan amount in post-closing liquidity (cash and marketable securities outside retirement accounts).
- Does the buyer have experience owning commercial real estate properties? Experience is generally more important in MTNL acquisition than for STNL.
Facts about the property that are important to potential lenders include:
- Financial strength of the tenant (STNL) or tenants (MTNL).
- Remaining lease term, including the weighted average # of years to lease expiration in MTNL. For STNL, lenders want an absolute minimum five years remaining lease term and most require at least 7-8 years left on the lease.
- Mix of tenants in MTNL – national, regional, local.
- Location of the property – primary, secondary, tertiary or remote market.
- Demographics of the location, especially the population in a 5-mile radius of the site.
Tenants can be generally classified in these categories:
- Public companies with “investment grade” bond rating. The investment grade ratings from Standard & Poor’s (S&P) are AAA (highest) through BBB- or equivalent rating from Moody’s. These are the strongest and most desired tenants due to lower risk of lease default.
- Public companies with lower than “investment grade” bond rating (BB+ or lower).
- Large private companies which may have a bond rating but usually do not.
- Franchisees of national brands – lenders usually want the tenant to be operating 20+ and preferably 40+ units.
- Local tenants or other operators of non-national brands.
- Tenants that currently have an investment grade bond rating include Walgreens, CVS, Fresenius Medical Care, DaVita Dialysis, O’Reilly Auto Parts, Advance Auto Parts, AutoZone, Starbucks, Sherwin-Williams, Tractor Supply, Dollar General, Family Dollar and Dollar Tree.
- Many Offering Memos (OM) will state the tenant is a “credit tenant” but from a lending standpoint, the only credit tenants are those with investment grade bond ratings (#1 above).
- OMs will also sometimes refer to lease guarantor as “Corporate” but that does not mean much. The lease documents must be inspected to ensure that the investment grade company is the lease guarantor (as in #1 above) or in tenant types 2-4 above, the lease guarantor and/or tenant entity is sufficient to satisfy the lender’s requirements for tenant size.
- If a private company or a franchisee is the single tenant or a large tenant in a MTNL property, the lender may require financial statements from the tenant.
Single Tenant Lenders
The best and most active lenders for STNL are those that specialize in financing STNL with a national lending program. Some STNL lenders will only consider properties with the top tenants (see #1 above). Others will consider most any national brand tenants (#s 1-4 above) but virtually none will finance properties with local tenants (#5 above).
National STNL lenders are typically commercial banks and credit unions that have a specialty finance group within the company that focuses exclusively on financing STNL properties. These STNL groups are very professional and exceptionally reliable to 69
close on the terms they quote early in the process. The minimum loan amount for commercial banks and credit unions ranges from $500,000 to $1,000,000. Life insurance lenders will typically have a higher minimum loan amount.
MTNL lenders are more numerous and varied in their approaches. Some have national lending programs and others are regional in scope. Lenders expect that MTNLs will have a mix of tenant types. MTNL lenders get cautious when the property exhibits certain risks such as a large tenant that is weak or the lease has a near-term expiration, weighted average remaining lease term is short (<5 years) or the property is located in a market that is declining in population, has low population or has high vacancy.
Loan terms will significantly vary based on the property, location, tenant(s) and amount of leverage the buyer is requesting. Below is a general guideline:
Loan terms are generally superior for
(a) financially strong tenants,
(b) longer lease terms,
(c) locations in vibrant markets with dense population and
(d) lower leverage loan requests.
Loan Application Process
- When a buyer is considering a property to acquire, and the buyer will need financing, the loan application and closing process is managed by the commercial mortgage broker and generally follows this direction:
- Initial conversation with client to clarify client situation and financing objectives.
- Collect financial information from buyer such as personal financial statement (PFS), schedule of real estate holdings (SREO), tax returns, bank & brokerage statements, resume, etc.
- Obtain “soft quotes” from potential lenders that are considered the best financing sources given the client situation and specific property/tenant.
- Provide guidance to the client regarding relative advantages of each lender quote.
- Buyer selects the lender with which to apply for the loan.
- Buyer signs fee agreement engaging mortgage broker to exclusively represent the client to arrange the financing and close the loan.
- Prepare application documents for buyer to sign; buyer sends deposit to lender for third party reports (appraisal, Phase I report, survey).
- Schedule site visits for third-party vendors through the listing broker.
- Ensure that Estoppel and SNDA documents are ordered from the tenant(s) with correct data.
- Work with lender’s loan processing team, real estate brokers, title company, attorneys and third-party vendors to close the loan and complete the acquisition transaction.