Understanding Commercial Mortgages-The Who

Welcome to the world of commercial mortgages. This is the first part of 3 part series that is written to the individual who is venturing out into the world of commercial investment. It is written to introduce you to some of the differences between residential loans and commercial loans and hopefully help you to be more profitable in your quest for diversifying your income through commercial properties. I will endeavor to teach you the who, what, and why of commercial loans. A big part of your success as a commercial investor is in choosing the right mortgage for the property so it just makes sense to learn about commercial mortgages. What follows is the straight scoop on commercial mortgages.Knowledge is power; my goal is to give you that knowledge-accurate knowledge. And so, let’s begin.

WHO?

Who lends the money in the commercial realm? This is the first and possibly most important difference between commercial and residential. Yes, you apply to a large lender or bank or some financial institution whenever you do a residential loan. But the money is not really lent by that institution. It is for a few days. But ultimately they sell the loan to FNMA or FHLMC and get reimbursed the money. They just keep the servicing rights. Fannie or Freddie then bundle all those loans and pass them through to investors as mortgage backed securities. In other words, the bank is not really lending their own money. It is not that way in commercial. In the commercial realm, most loans are done by banks and it is their own money. They take the money on deposit with them and loan it out to different companies. There is no giant like FNMA waiting to reimburse them. If that loan goes into default the bank is stuck unless they can sell the property for a profit. Because of this, they are much more picky than they would be on residential loans.

But that is not all. 80% of all businesses fail within 2 years and if someone does fall into financial difficulty they will let their commercial investment go before the house that their wife and kids live in. Commercial loans are investment loans and you know full well the rules are stricter on investment loans. Because each piece of property is completely different, commercial deals are not hard and fast. No standard qualifying ratios here. The property is more important then the borrower. You can have an excellent borrower but have a bad property and no one will buy the loan. I had a loan officer call me mad as anything that his client’s loan was denied by our underwriter. His message was something like this, “ I have a guy with perfect credit, great income, a property worth $450,000 and all he wants is a little cash out loan of $300,000. You must be an idiot if you can not get this loan done.”

So I pulled the loan, and much of what he said was true. The borrower’s credit was perfect and his income was good-except on the property. The property itself was losing money. His borrower told him the property was worth $450,000 but based on the cash flow, it would not appraise for more than $150,000(more on appraisals later). No one is going to loan $300,000 on a place only worth $150,000!

In talking to him, it turns out he has been trying to get it approved for over a year! Commercial loans are deal specific. Understand that the bank is loaning their own money and they will be very picky on what they will lend on. The good news is that if the deal is good, there is more than enough commercial money available-banks WANT to lend. They are just more careful when it is their own money.