Daily Observations - Add Backs

Today's blog deals with the subject of Add Backs. Simply stated add backs are just that, they are the expenses that a seller has deducted on their Profit and Loss or on their tax returns which should be credited back. Credited back only means that a new buyer of the business should be able to add them back into the Profit and Loss as a credit rather than a debit to determine what is known as Seller's Discretionary Cash Flow.

Sellers discretionary cash flow is the money left over each month after all expenses have been paid to run the business including the payment of debt service on any outstanding loans.

The reason this is so important is that business brokers use this number to determine what a business should be valued at, or sold for. They then apply a multiple to this number to determine the selling price plus they can add back inventory and furniture fixture and equipment if of a significant value.

Typically the amount of credits that a bank will add back to determine profitability will not be the same add backs the business broker factors in to determine selling price. There is the problem with add backs. So if you are representing a seller or a buyer they must be made aware that the add backs that you are applying will not necessarily be the same add add backs that a bank will apply to determine if a business is eligible for financing.

Both broker and banker will always allow the following, depreciation, amortization, interest expense and any extraordinary one time expenditures. But that is where the similarities come to a stop. For more information on Qualifying for an SBA Loan read on.

Daily Observations - Seller Carry Back's

After reading the proposed SOP (Standard Operating Procedures) for the revised SBA 7A loan program it became plainly clear the importance of Seller Carry backs.

As a Financial Broker I always "push" seller carry backs for three reasons. The first is it helps the borrower with his cash flow if the seller is willing to hold a note. Second the lender likes the fact that the seller is still in the deal for training, etc, so to say, lastly it shows the confidence of the seller to both borrower and lender that they are willing to wait around for their cash while the new owner operates the business. If a seller is not willing to hold any paper it almost makes that person and the transaction look suspect, demonstrating that they have no faith in the future cash flow of the business to make both the seller carry back payment and the first trust deed payment to the lender.

However with the advent of the new SBA SOP revision it now becomes a mandate that the lender will try to get a carry back for any goodwill value of the business. The gist of the proposed language is as follows:

Lender should explore seller financing collateralized by a lien position subordinate to the SBA lien - Amount of seller financing that should be considered - amount being used for the acquisition of intangible assets such as goodwill. SBA has verbally advised that if seller refuses lender must document.

As you can see from this blurb seller financing after August 1, 2008 the proposed effective date of the revision shall be more important than ever. Get your clients ready. Seller Carry Back Notes are here to stay.

Daily Observation - Truth and Tax Returns

Continuing on with our theme from yesterday the truth, I wanted to share an incident that we heard about today. A referral client came in and presented the tax returns and profit and loss statement of business to the Broker that he was considering. The client relayed to the Broker that the returns did not adequately reflect the real income of the business.

It was also told that the purchase price was X but when the broker did her calculations based on the income from the return the selling price should have been more like X-Y, a significant difference. Because of the strength of the buyer the amount of his down payment and the collateral that he was willing to post the broker most likely would have been able to secure a lender for the loan amount that he needed, even though the business on paper did not cash flow.

So everything should have been all right even though the owner did not report all of his income. Right? Wrong!

Even though the broker was able to get over all the obstacles there is one that she would not be able to get over. SBA requires an independent valuation of the business for larger loans. Therefore a business valuation would be procured, and there is no way ever that the business valuation would yield any where near the selling price of the business.

So you must be aware of all the aspects of a loan, not just the 5C's +E, but also what the business is worth based on Official Records, not the word of the owner, or reconciled cash receipts. Bankers in addition will also apply Business Ratios to determine the real value of a business as well.

Daily Observations - Will The Real Direct Lender Please Stand Up

I may be dating myself but if you remember the show to Tell The Truth with Bill Cullen, Betty White and a host of other great actors and actresses, would the real Direct Lender stand Up is quite an appropriate caption.

On the show there are two imposters as well as the real individual. The panel then asks questions to decipher which one of the contestants are telling the truth, and which has swayed the panel into believing they were telling the truth. This is what is exactly happening in our lending community. Brokers, Mortgage Bankers, Private Lenders are all telling the same story, Yes we are a Direct Lender.

Why is it important to only deal with a direct lender? The answer is quite simple. By dealing only with a direct lender there are no other brokers or middlemen in the transactions which causes a more expensive deal for your client. Why is this a problem? The reason it is a problem is everyone wants to be a direct so that they have the opportunity to broker those loans they do not want to portfolio.

So even if you talk to a broker and they tell you they are a direct lender, you MUST ask more questions regarding the percentage of deals they close direct versus the percentage of the deals they broker out. If you find they broker out more than 50% of their deals, in my mind they are not a direct they are only using that small percentage of loans to misrepresent their real status of a broker.

We are the first to tell anyone who calls us that we are a broker and not a Direct Lender, everyone else should do the same as well. For more on the Role of the Financial Broker read on.

Daily Observations - Loan to Cost

Today's observation has to do with more changes that we are seeing as lenders continue to tighten loan parameters. Loan to cost is that ratio of the new loan to the total cost of the project. Three to six months ago loan to cost for a good project would be between 80 to 90% loan to cost. So the theory would be that if the developer / borrower owned the land free and clear we would be able to get them a construction loan with no out of pocket funds. This would work with a loan to cost around 85% on average.

We did a lot of construction deals this way, land free and clear, equity in the soft costs therefore no money would be needed to close the construction loan.

Fast forward to today. Lenders are not offering 85 to 90% loan to cost on new construction anymore they are offering between 65 and 75% loan to cost. This translates to borrowers having to put additional funds into construction deals and not just relying on the value of the land and the soft costs any more. This is why the liquidity of the borrower has become so important to the overall financing plan. Loan to cost is only applicable to Construction Loan funding.

Don't confuse loan to cost to loan to value - they are not related other than there is a ratio. Loan to value reflects down payment while loan to cost reflect building expenditures as compared to the overall finished construction value.

Daily Observations - Response to Annonymous

Question: Can the forecasted profit be substituted for NOI to come up with a Rate of Return for the new project? Thank you for your time, we're all looking forward to hearing your answer...

Forecasted profits are just that forecast and as such for NOI calculations they are not applicable. the only thing we can use with forecasts is the ability to calculate a projected a Debt Service Coverage Ratio to determine if a project pencils. Every developer always tries to predict an ROI (Retrun on Investment) or better yet strive for a specific ROI.

But the problem is not what the developers are shooting for, its what the lenders get. Since the lenders today are not taking any chances on anything as I have continued to report in these messages, they will substantially discount any projections. As such they become almost worthless to the lender. For certain type of projects lenders will use their own database of acquired knowledge to calculate forecasted Debt Service Coverage Ratio based on certain known norms in the industry as reported in proven reports such as the Star Report for Hotels for example.

Thank you for the informative question, keep them coming and I will try to answer them all.

Daily Observation - CA Here We Go - Away

What's happening when you cannot afford to buy property in our own home state? My clients are all looking outside of CA, and that's not a good thing for our economy!

CAP Rates at 4 and 5 are causing all deals not to pencil. What's the answer buy out of state, and that is what's happening. When you can find 9's 10's and even higher why would you buy in state.

For those of you who are not familiar with CAP Rates the lower the CAP Rate the more expensive the property and thus the debt service increases. Therefore higher CAP Rates yield lower purchase prices and therefore affordable debt service.

So if you are in a 1031 exchaange and you have to identify properties look out of state. To see how the CAP Rates work take the NOI divide it into the purchase price and that will yield the CAP Rate, or conversely if you know the NOI and you know market CAP Rates that will yield you the purchase price by taking the NOI divided by the CAP Rate.

Read on for a full explanation of CAP Rates

Daily Observations - Non Recourse Loans

Recourse versus non-recourse loans. Everyone wants a Non-Recourse Loan. Which means that the underlying property is the security for the loan and nothing else. There are no personal guarantees, just the property.

So lets take advantage of this and get me a non-recourse loan is the chant I hear everyday.

The truth is there are no more non-recourse loans for construction, and if you are lucky enough to find one for a permanent loan, you better be a PERFECT candidate. Every one of the C's + E must be perfect. Credit, Collateral in the property, Capacity to cover the debt service by at least 20% to 30%, Character , model financial citizen, Contribution, a significant down payment, and Experience. Lenders are looking more and more to the experience of the investor. No longer can their owning one type of investment property carry over for experience in a different type of investment property,

Experience has become the KEY in 2008 for financing. To see if you would qualify for a non-recourse refinancing fill out our No Obligation Professional Loan Analysis.We will get back to you with the results of our analysis immediately.

Daily Observation - Tax Returns

Today's Observation is not really an observation per se, but more of a lesson that needs to be shared with borrower's of all types. I was recently asked to present to a group of business brokers my take on financing and what advice I could share with them to have a more successful career.

After talking to them for about an hour about the basics of financing including the 5C's +E, if you don't know what I am referring to please e-mail and I will be delighted to share this information. I stressed the importance of looking and studying the tax returns. For the sale of a business the purchase price is derived at by looking at the returns to determine the sellers discretionary cash flow plus either inventory or FF&E. The above is a gross generalization as each business has a separate formula that needs to be applied to ascertain its real value. But the important point was that it is the tax returns that will prove or disprove that value.

Investors and sellers have to realize if they do not reflect what the true income of a project is, they will lose out and not get the proper valuation for their investment that they are trying to sell. So either pay less money in taxes and have a lower sales price or pay your actual taxes by reflecting what you are really earning and get a larger valuation for your business.

With the actual income reported in the tax returns it becomes an easier task for the bank to determine if they will lend against the property, as they can compare tax earnings over the last couple of years to calculate the Debt Service Coverage Ratio which is the most important ratio a bank will analyze when making a loan determination. Stronger tax returns always equals a higher probability of getting a deal funded.

Daily Observation - True Cost of Capital

Today's observation came to me while reading a book about Capital. It is very apparent that most people borrowers, as well as lenders are not aware of the true cost of capital for a transaction. Capital can be both physical, the stuff we buy things with, or intellectual capital, that knowledge we have to acquire things with. In the long run intellectual capital may be the more expensive of the two, but more about that on another blog.

Let's focus in on the money aspect of the cost of capital.

Capital providers, whether they are banks, asset-based lenders, mezzanine lenders. or private equity funds, neither post prices for their capital nor typically announce the characteristics the borrowers must possess to access their money.

Although, its not disclosed, every capital source has a "credit box" which describes the criteria necessary access their funds. For example, most banks are cash flow talkers but in actuality are collateral lenders.

Credit providers expect to receive certain returns for their capital. These rate of returns consider all of the terms for the investment such as origination costs, compensating balances and monitoring fees. Once a business owner knows the full cost they then can compare different investments and their returns. All of the above are based on Return on Investment.

Daily Observations - Banks Want Your Deposits

Is there any one way to guarantee that your loan is going to be funded, well maybe not guranteed but increase the odds significantly for loan approval?

The answer is yes, increase your banking relationship with the lender you are talking to. Today more than ever banks want increased deposits. More and more banks are increasing their deposit base so that they have greater capitalization. If a bank is not properly capitalized they can be shut down by the Regulators. So to avoid any capitalization issues the lenders as well as the bankers are all looking for increased deposit base.

What better way to get deposits than to entice large depositors with the lure of loan approvals. Lenders that are getting these additional deposits are feeling more comfortable lending money to their clients. With most lenders new banking relationships are not being afforded this additional enticement, it is only being offered to existing deposit relationships that bring in additional capital to their accounts. However, the smaller local banks may be offerring this incentive.

Our Knowledgebase has other factors that lenders look at to determine if they will approve your loan.

Daily Observation - Restaurants Are Next to Be Hit

With the economy going every way but up, With Banks getting tougher and tougher on lending, its no surprise that I heard from one lender today, that they may not be lending to any restaurants for a while.

Their logic is that with gas prices going up and the economy side stepping people will not be eating out as much, and as such restaurant loans become a bad risk. Now saying that if you are in the restaurant industry and believe you will be needing capital in the short term, GET IT NOW. Don't wait. The words I shared with you are from one lender, this has no swept across the lending industry yet.

If you are in the industry and can show positive cash flow as well as supporting collateral now is the time to close that loan. To see what we can do for you read What Makes Us Different. Don't delay start your loan process immediately.

Daily Observation - Private Lender Update

Just a short blog this evening, and the topic is private money lenders. I first have to say that I am still being inundated with propaganda from lenders telling me they can finance this or they can fiance that. But you know what? When you ask them about a specific project their answer is no we don't do that anymore. Or no we are not financing land anymore.

But why do they consistently send out advertising material asking for these loans, if they are not going to fund them. I have no answer to that question, but just be aware that loan programs are changing drastically. Work with someone that you know and trust. Don't follow up with lenders that are mailing you mass material so that they can bait and switch you or your client.

I want to leave you with this point tonight. I received an e-mail from a hard money lender who was always looking for land deals. We followed up with him about three weeks ago and stated that we had a deal that met all his requirements that he posted in his blurb looking for deals. He told us that he could not do the deal for us as it did not match his current lending criteria.

Well today I receive an e-mail from that same lender stating they are now looking for small deals only 25 k to 100K, boy have things changed!

View our recent closings to see the type of quality deals we are consistently closing.

Daily Observation - Tenants Beware

Today’s observation is another one similar to the one regarding equity lines of credit being arbitrarily reduced. Instead tonight we are discussing something that is even more unheard of.

Landlords are at fault in this observation not banks, but I wanted to bring this practice out in the open so you can share it with all of your clients that may be in a rental situation.

Here it is. Landlords are collecting the rent from the tenants but they are not paying their mortgages so the renters are losing their place to live as the lenders are foreclosing on the owners who are in default. This is not as rapid spreading as the equity lines of credit and credit card authorization amounts being reduced. But it is getting press and you need to find ways to protect your tenants. I am not here to suggest any methods of protection as this is out of my field of expertise.

We just want you to be aware of this practice and the more we can help the consumer the better it is for everyone. For additional information find out What Makes Us Different .

WARNING - Equity Line of Credits are being REDUCED

I don't know how much clearer I can make this statement, EQUITY LINE OF CREDITS ARE BEING REDUCED WITHOUT ANY NOTICE

If you have been using a home equity line of credit for any project don't rely on the Loan Amount that you were approved for. Banks are unilaterally reducing lines of credit because they feel that the underlining property values have declined that they are automatically reducing your line of credit.

Without notice they are causing 1000's of people to have projects on hold, causing bounced checks because individuals are relying on their available credit to write a check and then the bank is declining payment.

The public must be made aware of this tactic. Not the banks have done anything illegal, they haven't, but immoral you bet your last nickel. By them reducing lines of credit without any notification, causing people with good credit to bounce checks, and then saying that they are sorry and it is the first time in seven years when the bank had to do this.

The banks position and I quote is that they want to protect the consumer from being too much in debt secured by an asset that is falling in value. If this is not becoming a self fulfilling prophesy I don't know what is. The banks are using property comps for homes that were either foreclosed or sold as short sales, then they are saying that all properties are now lower because of the comps.

Now its not that the consumers are late, its not that the consumers havc problem loans, but arbitrarily without even an appraisal they are lowering lines of credit.

I could go on for hours as to the problems this has caused the 1000's of people who have been affected by this bank policy. Including me today!

PLEASE GET THE WORD OUT TO EVERYONE YOU KNOW ABOUT THIS. DO NOT LET THEM BECOME THE NEXT VICTIM OF THIS PRACTICE.

I am available for comment or to be interviewed about this. Please have any newspaper reporters, television reporters contact me. I can be reached at harlan@loanforbiz.com or858-592-0659 x 101

Daily Observations - Loan to Value

If anything that has changed to complicate the underwriting process it is Loan to Value. Today the LTV's as they are affectionately known are all over the board. LTV's used to be as high as 90 to even 95% but with the advent of the sub prime debacle, loan to values have been reduced precipitously.

Where a land loan used to be at a 75% loan to value which means if the property appraised at $1,000,000 the bank would lend you $650,000 today we would be lucky to find a bank lending $550,000 for a straight land deal. Also the loan to value that many lenders are quoting will affected by the CAP Rate of the property as well as the net income. If the net income cannot support the needed debt service coverage ratio, the lender will lower his loan amount to meet the DSCR, and thus LTV will also fall accordingly.

I cannot blame these lenders from lowering the amount they loan, but what I fault them for is allowing the current foreclosure market to dictate what a property is really worth. by using comps from foreclosed and short sale properties, which is bringing down the amount of value that borrowers without credit problems have for their homes that they want to use as collateral. More about this issue another day.

To understand collateral you must understand What CAP Rates

Daily Observation - Neighborhood Banks

Best Friend or Worst Enemy?

Just got off the phone today with a few of the neighborhood banks looking for financing. to sum up all the conversation's in a nut shell this is what we were told.

If a client or a prospective client does not have a current banking relationship with the bank or if they are not willing to establish a significant one we are not going to even waste our time looking at a loan request.

Get this the neighborhood banks where the property is ten feet from the banks door is not even interested in talking unless you can become a "serious" bank depositor.

This is really scary from a lending perspective. If the neighborhood banks don't want the "local" deals who does? Just a thought to ponder.

The neighborhood banks used to be the lenders you would to go to when all other lenders were not interested in your "special circumstance", the local banks would always step up to the plate. Today we're hearing they are not interested. For more of the role of the banker, Business Development Officer and Broker request a copy of my article by sending an email to harlan@loanfrobiz.com.

Daily Observations - Down Payments

Just because a lender states they offer a 75% LTV or loan to value does not mean that you will get a 75% loan to value loan.

The reason is quite simple. All lenders look not only at the LTV for a project but more importantly look to the cash value that is generated from the project. If there is not enough cash flow to support the required debt service coverage ratio that the lender needs for approval, they will lower the loan amount they are willing to lend therefore also lowering the loan to value that they are offering you.

Remember loan components cannot be viewed in a vacuum, but must be looked at together. CAP rates dictate purchase price and Return on Investment determine if the project makes economic sense when you determine how much of a down payment you REALLY have to come up with.