Financing Commercial Properties
In part 4 of our commercial real estate series, we reviewed the basics on how to analyze deals, and now we will discuss how to structure financing. To create a credible offer, you must have a financial plan in place and be ready to articulate that to the seller. In today’s hyper competitive real estate environment, the strongest offer is often the one that has the best financing plan. We recommend you get the financing question figured out before writing any LOI’s.
Commercial properties (including multi-family) are typically financed with commercial loans. The exception is multi-family 2-4 unit properties, which can be financed with conventional personal financing (30 year fixed mortgages). Commercial loans are typically shorter terms with balloon payments and pre-payment penalties. A lender that is providing a commercial loan looks to both the performance of the asset itself and the borrower’s credentials (ie net worth, liquidity, and experience). We’ll discuss that in detail below.
In most cases, we recommend using a loan broker to obtain the best financing options. A well-positioned broker can help you navigate the many available financing options and overcome the obstacles that are often present in commercial deals. Just like finding other team members, the best way to find a competent broker is to ask other experienced investors for referrals. The next step is to interview these brokers and make a determination which one is the best fit for you and your situation. Once you have selected a broker, they will tell you exactly what is needed to obtain a successful loan.
In considering how to structure a deal, the major question is how much money you (and any partners) have available to put in to the deal. Of course, the size of the deal itself and your structure will determine how much money is needed. The simplest form of financing would be for you to buy the property using your own financial resources only. This may or may not be possible for obvious reasons. Another option is to pool your money with one or more “active” investors, and use a JV agreement to define each person’s role(s), financial contributions and obligations. Getting the JV agreement defined and agreed upon upfront is critical and another entire subject matter. If a JV is not practical to execute, the last option we will discuss here is syndication, which is simply the pooling of 2 or more person’s money to buy an asset. Next we will discuss syndication in more detail.
Syndication is an effective way to raise money for larger deals, however there are challenges to consider. For starters, the SEC regulates all syndications because capital is being raised from “passive” investors. That means many things that a syndication attorney can help you better understand. It is important to first define what type of investors you will be raising money. The SEC will allow you to raise money from “accredited” investors or “sophisticated” investors, however different rules apply that are beyond the scope of this discussion. Just note that an accredited investor is defined as someone with a net worth of $1M (excluding primary residence) and/or $200K in annual income the past 2 years ($300K per married couple). A sophisticated investor is defined as somebody with significant business and/or real estate investing experience.
The syndication structure is generally made up of several parts, including a sponsor of the deal (the person obtaining the bank financing), the management team (of which the sponsor will be a part of) and the passive investors. Passive investors will often be given a preferred return, and only after that is paid are the members of the management team paid their defined split. This arrangement helps keep everybody’s interests properly aligned (ie management team is incentivized to maximize performance of the asset in order to be paid).
This is a very general overview of financing, and as you can imagine, there are many moving parts that have to be coordinated and thought-out. The most important tip I can provide is that you must plan this part of the buying process before writing any offers. That includes getting partners lined up with specific financial commitments, so that your chance of closing a deal successfully is maximized. As always, we are here to answer any questions and provide guidance.