Daily Observations - Prohibitive List

As the lending environment starts to adapt and adopt to the new credit and lending parameters we are seeing more and more lenders actually refusing to do certain types of businesses.

Each lender / bank is thoroughly looking at all their past transactions and trying to determine any negative patterns. For example if all of a sudden bank A has an excessive amount of work outs and foreclosures on escrow companies they may immediately determine that they do not want any more escrow companys. This actually happened to me, we had a deal in final underwriting and at the loan committee, one director / officer had a credit problem with an escrow company they approved and they therefore denied my deal for that only reason.

This pattern is very prevalent today. Instead of receiving rate sheets and propaganda every day I am now getting prohibitive lists. Just yesterday one of my newer lenders that I am working with were very happy to provide me with a list of deals they will never look at. I asked them if there were any extenuating circumstances that would allow the lender to look at a particular transaction, and the answer was flat no.

So my advice this evening is before you submit a biz loan to a lender check first with their growing prohibitive transaction list.

For more of SBA Loans please visit loanforbiz.com.

Daily Observations - Earn Outs

After last nights blog I have been asked more and more questions about the entire concept of Earn Outs. Over the next couple of days a very close friend of mine, Dr. Larry Lerner a specialist in business intermediary transactions has offered his expertise to our readers.

As I am not an expert on this area I will touch on it and wait for Dr. Lerner's expert commentary.

To whom does the Earn Out benefit?

The interesting answer to this is it depends.

It could benefit the seller if the seller is unable to get his purchase price and he has complete confidence in the value of his business. He must not be concerned about the new purchasers ability to run, maintain and build the business. If the seller is concerned that the new buyer will not build the business then the likelihood that the seller will accept the terms of the Earn Out are reduced substantially.

It could also benefit the buyer if the buyer is concerned that contracts that the seller has represented may not transfer to the new buyer. For example a buyer is counting on the continuation of purchase contracts from one particular customer. If the customer should happen to not renew the contract then the buyers expected cash flow will be significantly reduced. If there is an Earn Out then the purchase price of the business will be much less than if the cash flow supported the strike price.

The above are just two examples of how the Earn Out benefits both buyer and or seller.

Daily Observations - What Am I To Do?

Tonight's observation asks the question what happens if the deal just does not cash flow, is it dead? My favorite answer to that question is of course It Depends!

While thinking outside of the box is our forte, some time all that creativity can really pay off. Here's an example that I want to share with you.

We were approached on an SBA Loan for the acquisition of a business. The business would not debt service at a greater amount than 1:1, which means that the lender, was not willing to lend the requested amount. The first thought of course is to have the seller carry paper with no payments for a period of time. Most of the covenants that I have read regarding seller carry-backs states that the seller cannot be paid off prior to the SBA Lender being paid off.

However, many of these covenants are not enforced as long as the loan is current, if however the loan goes into default the SBA will find out that the seller was getting paid back in violation of the loan covenants and that can present a serious problem. So I would not recommend this alternative.

Another idea is that of a separate agreement outside of escrow which can be a note between buyer and seller, but again that can create problems for the same reason as above.

The new twist is to structure an Earn Out. An Earn Out allows the seller to lower the price of the business and the buyer to borrow less money, therefore the cash flow would support the eventual sale in our first example. The borrower/buyer and seller agree to a strike price in earnings, and when that amount is earned, the seller starts to receive 50% or whatever amount was agreed to of all earnings in excess of the strike price.

The seller in essence gets a deferred increase in the price of his business that he sells. The buyer get a deferral on the amount he pays. In the end everyone wins as long as the new business does the projected amount of future cash flow.

For more on creative financing techniques visit loanforbiz.com.

Daily Observations - More Collateral Issues

I hope you are beginning to see the trend in these blogs. I am stressing what the lenders are stressing. I am trying to point out the issues that are preventing lenders from issuing "real" LOI's. By real, I mean that the deal has a reasonable chance of funding, and that a good portion of the underwriting has been accomplished.

Tonight I want to continue with the issue of rolling stock as a form of collateral. For those readers that are not familiar with rolling stock, it simply is assets that can be easily moved from one location to the next with minimum effort. Examples of rolling stock would be company's that have primarily vehicles, boats, buses, or any type of asset that can be mobile, hence the term "rolling".

The banks are simply not lending on rolling stock without any other form of collateral for security. Simply stated a "biz op" that is mostly made up of assets that are considered rolling stock will definitely have to have additional collateral, or the buyer must put down a substantial down payment. We heard today of one lender that was willing to finance the rolling stock but the borrower had direct experience, and was putting down over 50% of the purchase price.

I believe this again is a new trend that we all need to be aware of. If you have a client that is looking to fund rolling stock through the SBA program, you may want to look to an equipment financing company or leasing company rather than to a SBA Lender.

For more on SBA owner user financing programs visit loanforbiz.com today.

Daily Observations - Collateral Continued

If you recall on Thursday night I shared with you the calculations that a bank will use to determine available collateral. The reason I did this was for the average person to realize that what they believe they have in equity, they may not have. It is very important that any borrower who is planning on using real estate as collateral realize that the equity position that they thought they have may be very different after the bank does their calculations.

The above statement may sound very negative, but it's important to realize where you stand, while going for a loan. By knowing that collateral is an issue the borrower can offer other alternatives to the lender. There are even some lenders now that are strictly cash flow lenders and are not concerned with the collateral. However, even if the pledged Real Estate has no equity the lender may opt to secure their interest by putting a lien on the property.

Another source of collateral for a business purchase may be the actual equipment that the borrower is purchasing. For example, a manufacturer may have hundreds of thousands of dollars worth of equipment that can assist the borrower as pledged collateral. The only thing to remember is that the evaluation of the equipment must be as if it was sold at a force liquidation sale.

For more information on the different type of loans that loanforbiz offers please visit our website.

Daily Observations - Collateral Evaluation

Just a quick note and right to the point. There are many misinterpretations as to how a bank will evaluate collateral. The following is the calculation that most lenders apply to determine Equity in a piece of property.

Step One - Take your Best Opinion of Value, hopefully what a professional says the property is worth, sometimes called a BOV, or a Broker Opinion of Value.

Step Two - Discount that value by the amount of at least 20%, because most lender will only allow 80% value to the real estate collateral.

Step Three - Now subtract any and all liens / debts against that property, including any other liens that the property has been pledged to support.

The remaining amount is the collateral value that a bank will apply as security for the loan.

NOTE - Some lenders apply even more stringent calculations.

For more on investment property and collateral value visit loanforbiz.com .

Daily Observations - CAP Rates Revisited

Tonight's observation is almost a review of what's been happening in the marketplace. If you have been a regular reader of this blog you will remember what I stated that many investors are leaving California, and looking towards other states with higher CAP Rates.

As a quick review CAP Rates are the benchmark indicators if an investment will return a significant return on investment. There is an inverse relationship between a capitalization rate and the purchase price of a property as well as the net operating income. As the Rate goes up the property value goes down, and the net operating income as a percentage of the purchase price increases. What that means is a low a price property with a significant net operating income will yield a higher Rate; then a higher price property, would with that same significant net operating income.

The lender will analyze the net operating income as compared to the purchase price to determine the loan to value they are willing to lend on.

Therefore, as the Rate goes up, the loan to value also goes up, which in turn increases the capitalization rate. Because of the economy in California, and the fact that we are in a buyer's market, we are now seeing purchase prices of property decrease as the cash flow remains the same. This means that an investor now can get a better return on their money here in California, versus leaving the state.

I'm not saying at this point that the investors are returning to the market in droves, but I personally believe that as prices drop as they have been doing, the investors will start returning to California, and then market values will once again begin to increase.

Because of this anomaly that is occurring now it might be the best time to look at purchasing property as either an investor or an owner user. We have owner user financing at 90% loan to value and rates in the mid 6's.

For further information, contact us or visit our website loanforbiz.com.

Daily Observations - No Posting Tonight

"Flash of Lightning" our bi-monhtly newsletter is being sent out instead. Please check your inbox for the latest issue.

We will continue tomorrow night with the next Daily Observation.

Daily Observations- New Role of the Underwriter

As I like to share with you each evening, interesting facts that happened to us during the day, today I found out that underwriters are having a new role. Traditionally, the underwriter is involved after the business development officer has done a thorough analysis to determine the feasibility of the project.

However, because of today's economic environment, the underwriter for the financial institution is getting involved in the initial discussion with a client as well as with the business development officer. The business development officer rather than making a final determination to issue a letter of intent or not are being instructed to run all deals by the underwriter.

I can understand this new way of thinking for very large transactions, but I was appalled today to have this process applied to a $375,000 loan for a strip center. The business development officer reflected to me that he was unable to issue any preliminary letters of intent without the underwriter "blessing" the proposed financing.

What this indicates is that the role of the business development officer, in certain financial institutions is either going to be significantly diminished in capacity, or at the worst be removed from the process. If I look at some of our current business development officer that we work with, there have been definite transitions in their individual status, as well as their employment.

Could this be the future of the business development officer?

For more information on the perceived role of the business development officer, or financial broker, please visit loanforbiz.com.

Daily Observations - Broker Chains

This evening I would like to address the issue of broker chains. What are broker chains? Broker chains are when one mortgage broker contacts another mortgage broker, who contacts a third mortgage broker trying to get a loan closed.

Why would I address the issue of broker chains? It appears that all the large transactions that all the brokers are talking about are part of a broker chain. From my experience 99.9% of all the broker chains never close. The reason they never close is that there are too many participants between the lender and the principal. With so many brokers to go through to actually reach the principal, the deals just never come to fruition.

If we get a call about a large transaction, and we find out that there is more than one broker between us, the lender, and the principal, we pass on the deal. I cannot recommend enough to other brokers to do the same.

What we have found is that many of the new loan originators get involved in broker chains, and wait, and wait, until they find out that there really is no deal there. The problem is that the new loan originator has chosen to wait for the big fish, and has not continued to prospect for the smaller fish; the ones that can be caught regularly.

If I can share any words of wisdom from my past transactions don't wait for the big one. It may never come. Go to work every day, finding small business and commercial loans, and leave the broker chains to the other mortgage brokers.

For more on investment property and the role of the financial broker, please visit loanforbiz.com.

Daily Observations - Thinking Outside of the Box

If traditional funding sources are consistently making it harder and harder to finance Business Opportunities and Commercial Loans, are there other alternatives?

The answer is YES, you just have to look deeper into the transactions. The ability to look deeper is the key to being an effective loan broker. They should look at all the assets of a company and determine if there is another way to get the same results with a different approach.

Let me give you an example of what happened to us about three months ago. We were referred a client that was not a US citizen or a holder of a Green Card and he wanted to purchase a business with an SBA Loan. The problem is that SBA precludes lending to a non-US citizen. The client had the down payment for the purchase of the business, but we could not get him a loan.

But what we did was to get him an equipment financing loan for the vehicles he was buying, which happened to be equivalent to the requested SBA Loan. So by examining the assets of the business he was acquiring we were able to offer him financing of the same dollar amount but went about it differently.

Another source of funding for a biz op or commercial loan is to take a look at their accounts receivable or purchase contracts for work in progress. There may be the ability to leverage those assets as an asset based loan.

So tonight I want you to ponder other alternatives to traditional financing. View our website loanforbiz for further info on various other financing methods.

Daily Observations - What's Needed Now

Continuing with our Oklahoma scenario, buyer found a new property. In order that they don't have to go through the same "story" again they have asked us to determine if this property is financeable.

Therefore for today's blog I am going to share with you the list of the requested information by the banker to determine if they have an interest in this project. So I am going to present you with the list so that you too can learn what are the components of a pre-approval determination.

1. the address of the property to do a demographic study on the project

2. a current rent role, with start lease dates and expected renewal dates

3. a breakdown of the property unit mix

4. a vacancy study to determine the history of the property as it relates to leasing it out

5. current operating statement

6. two years operating statements - again to determine the trend of the property

7. interim financial statement

8. pictures of the property.


Remember this list is only to determine the feasibility of the financing, not the approval of the loan. For that information stay tuned as we continue to follow the Oklahoma saga.

For more information on investment property visit loanforbiz.com.

Daily Observations - When All Else Fails

This will be the shortest blog I've written to date.

When all else fails its time to realize that not all deals are financeable.

If you've been following our loan saga over the last week about our Oklahoma property, we were turned down again. No one wants to finance this deal.

The lesson to learn from this is that NOT ALL DEALS CAN BE FINANCED, learn this well and you will be doing a great service for your clients.

Daily Observations- Location, Location, Location

Once again, the lending community has thrown us for a loop. Just when I thought we had it figured out, the lenders have gotten tougher and tougher. We were presented with a loan just the other day, that cash flowed, management had experience with smaller properties, and the money was sitting in a 1031 exchange.

You would think, that this would be an easy loan. What I did not share with you is that the property is located outside of California. The reason the investors were purchasing outside of California was that they can get a much more aggressive CAP Rate. The more aggressive Rate translates to better income return on investment for the client.

The lender turned down the loan, because the population of where the investment property was located was not great enough. This is the same loan that I talked about the other night, which had an occupancy of over 95%. So even though the property was fully, almost fully leased out, unbelievably, the lender still turned down the property.

The lesson to learn here for you and your clients is that you must take painstaking investigation of not only your property, but now you must be aware of all the demographics that may affect your property. Lenders are getting stricter and stricter about where they want to put their money. So the best advice I can offer you is be very aware of all of the aspects while selecting an investment piece of property for your clients.

We have not given up on this loan by any stretch of the imagination, but now we have to take a different track, as we talk directly to banks that are neighboring the property. If we're unable to get a local bank to be excited about this deal, then probably this is not the right property for our client.

For more about investor property please visit loanforbiz.com.

Daily Observations - Market Rents

I wanted to share with you an experience that happened to us on Friday, which I trust will be eye-opening for you as well as it was for us.

I have mentioned that when a lender looks at a project they always add additional expenses to determine the bottom Net Operating Income, such as the following:

Tenant Improvement Cost
Leasing Costs
Marketing Cost not necessarily included in the above
Reserves
Vacancy Factor will be applied even if property fully leased out
Management Fee even if on-site manager is there already, or owner will manage.

But what I never saw before is the following:

The Lender reduced the market rents that are being currently paid, because they felt that if they had to take the property back they would have to lower the rents.

Now I can understand raising the rents because they are below market, but not lowering them when they're at the market. To me the market rate should be the following:

What a willing renter is willing to pay a willing landlord, very similar to the definition of what a market price is for a piece of real estate.

But obviously in this market the lender would not agree.

Visit Loanforbiz.com for more information on investment property.

Daily Observations - Ground Leases Continued

Continuing with yesterday's theme of ground leases, I am pleased to announce that after further investigation. I was able to locate one lender, that would do everything that we wanted. So, if you have a ground lease. You will be able to do a loan for the term of the ground lease or less not greater, and at 90% loan-to-value, if the deal cash flows.

It just goes to show you that by making numerous phone calls, to numerous lenders, there are still deals out there ready to close. Lenders need to lend their money to good solid deals. A ground lease should not be considered a deterrent for a good solid deal.

The ground lease should only factor in as it relates to the cash flow for the project. Not for anything else. The rent paid for the property must obviously be factored into the cash flow to determine if the net operating income of the property can support the new debt service, as well as the ground lease.

It goes without saying that the underwriter would have to study the terms of the ground lease to make a final determination. The legal department would also want to review the ground lease to make sure that the collateral can be secured, and to ensure that there are no other legal barriers to the financing.

Visit Lightning Commercial Funding for more information on investor property loans.

Daily Observations - SBA and Ground Leases

Now that we have concluded the relevant portions of the adopted SBA-SOP, we are free to discuss more controversial issues.

Just today in my office the question of ground leases and SBA financing was raised. After I did my research with various local SBA lenders, the results were very eye-opening. There was absolute no consistency between any of the lenders as to their programs. The only consistency was that you may do this SBA loan with a ground lease.

Terms, maturities, and loan to values were all over the board. My only conclusion is that when ground leases are involved you must do your research to locate the best lender with the best terms and conditions.

As a summation of my research, I offer the following. One lender reduced their 90% loan-to-value to 75% loan-to-value. Just because of the ground lease. Another lender reduced the term of the loan. 10 years to reflect the effect of the ground lease. Very specifically the ground lease that I'm referring to had 27 years left to run. The lender reduced the term of the loan to 17 years. However, that lender still had a 90% loan-to-value program.

Another lender had the same 25 year term, but they reduced their equity requirement by 15% to 75% loan-to-value.

In conclusion, all ground leases need to be read thoroughly to determine the legality of even placing an SBA loan against the property. As you're all aware in a ground lease the payer of the lease does not own the property. FYI - Most ground leases are located, where there is public property, such as an airport, etc..

For more information on ground leases and the SBA, please visit the SBA.org website, or loanforbiz.com.

Daily Observations - Conclusions

The last area that I'd like to address is what can business brokers do to ensure the highest possibility of the successful financing. From my experience, the issue of direct experience, as well as future plans for the business are paramount. The projections as well as the business plan are examined very closely.

It is my recommendation that you the business broker work with the prospective buyer in formulating the cash flow projections as well as the new business plan. By having the buyer understand the cash flow model, he or she will be able to answer all questions from the underwriter.

It is very important that they do not just copy sales from one month to the 12 months and keep revenues flat. They should examine their projected monthly billing and reflect that accordingly in the cash flow model.

The importance of the business plan cannot be understated. The lenders are thoroughly examining this document drawing out relevant experience to develop a comfort level, as well as to determine quality of the individual requesting the financing. Because I have seen the emphasis placed on business plans Lightning Commercial Funding has created a 25 page business template that we are consistently using for our clients.

As a gift to all of you I would be delighted to share this document with you. Please send us an e-mail at MTeam@loanforbiz.com and we will send you the business plan. Visit our site at loanforbiz.com.

Daily Observations - Maturity of the Loan, Appraisal

Another change which benefits the buyer is that of the maturity of the loan. Originally, if the loan had a component of working capital as well as real estate. The maturity was a blended rate. The new requirement states that the maturity of the loan can be equivalent to the term of the predominant percentage financed; the entire loan will now have that longer term.

For example, if 20% of the new loan is for working capital, which is generally a seven year maturity the balance of the 80% is for the acquisition of real estate, the loan term and amortization would be for 25 years.The appraisal - for any property is now mandated that it must be requested by and prepared for the lender-the costs may be passed onto the borrower.

If new construction or substantial renovation of an existing building, the appraisal must estimate the market value upon completion. Once completed, the lender must obtain certification from the appraiser that the construction was completed according to plans.

If the collateral is existing building, not requiring construction. The appraiser should estimate the market value on an as is basis and if any other valuation method is used they must explain why. For other fixed assets, if the valuation exceeds the depreciated value an independent appraisal is required to support that high value

Visit Loanforbiz.com for more information.

Daily Observations - Collateral, Refinancing Debt

The rules for collateral have not changed, other than receivables and inventory are no longer included in the valuation of the collateral. The loan must still be fully secured at liquidation value.

Another requirement having to do with collateral requirements is life insurance. Life insurance is now required in an amount sufficient to repay the loans if the viability of the business is tied to one individual or individuals. The lender is allowed to factor in the amount of collateral available to repay the loan in the event of the death of the borrower into its determination of the appropriate amount of life insurance required.

On an aside re-financing of existing debt has been altered as well. This alteration is for the better. The previous requirement was that to refinance any outstanding debt. The aggregate amount of each individual debt must be improved by 20% before refinancing could be considered.

The new requirement is that the total amount of all the debt must be improved by 20% and therefore if some debt is less than 20%. It can now be refinance as long as the aggregate is a 20% saving or more. Visit Loanforbiz.com for more information on this exciting topic