Why Lending on Real Estate Could Be Better Than Owning

In today’s market, lending on commercial real estate is proving to be fiscally more prudent than buying it. Due to the weakening economy, the availability of commercial space is on the rise. Businesses across the nation are closing their doors. Most recently, Starbucks announced its plans to shutter 600 stores.

With vacancies steadily going up, tenants are in a position to negotiate lower lease rates. As a result, owners of commercial buildings are starting to see that the cash flow that they enjoyed nine months ago is beginning to dry up. At the same time, banks are not only tightening their lending practices but also becoming more aggressive in the valuation of property. They are raising cap rates, thereby lowering property values.

Reducing property values, combined with stricter lending criteria, are making it increasingly difficult for commercial property owners to obtain financing from conventional lenders for projects such as construction takeouts, rehabs, and lease ups, or for opportunistic purchases.

Unable to obtain loans from traditional sources, owners of commercial property are turning to private lending institutions for short terms loans. This has opened up a window of opportunity for private lending institutions to profit by making commercial real estate loans.

Unlike traditional lending institutions, private lender companies focus on a property’s assets, its loan to value, and the borrowers exit strategy. These lenders also look at a property’s "e;quick sale"e; value in the event of liquidation, in case a borrower defaults on the loan.

Private lending institutions, often backed by mortgage pool investor funds, provide collateral-based commercial loans with an average loan-to-value target of 65 percent, leaving 35 percent protective equity. The loans typically generate high returns, often as much as 10% to 12%. If the property is foreclosed, the lender company owns that property at 65 percent of its value. That discount is enough to cover the debt from the loan, as well as the lower lease rates tenants are paying.

Due to the turmoil in the traditional lending industry, private lending companies are seeing an upswing in loan requests.

They are increasingly funding asset-based real estate loans in order to give borrowers time to secure long-term loans from traditional lenders in the future. The following is an example of such a loan.

Recently, the owner of a newly-built, empty office building with a $500,000 construction loan that will be due at the end of the month came to us requesting a $1.5 million loan. Although the borrower has good credit, his banks were reluctant to finance an empty building at this time, even though the appraised value of the building is $2.75 million. One of the borrower’s requirements is that any loan he receives be a non-recourse loan, and that the property be the sole support of debt. His banks would only make the loan if it was a full-recourse loan.

We were able to negotiate a $1.2 million loan for twelve months at 12% interest with the office building being the sole support of his debt. The funds will enable him to pay off the construction loan, have reserves available to pay interest, and money available to move on to his next project. The loan will be repaid when the property is either sold, or leased and then refinanced with a long term loan from a conventional lender.

This is a win-win situation. The property owner received the money he needed to complete the project and move on to the next one. As lenders on the office building, we receive the monthly interest payments and, if he should default, the property can be sold 65% or more of its value.

You have to ask yourself the question... would you rather own a piece of commercial property now at 100% of its value, or loan on a property at 10 to 10% and know, if you do get the property back, you get it back at 65% of today’s value. In this market, I would rather lend on property than own it.

In today’s volatile real estate market, commercial property owners are seeing money going out, while private lending companies are seeing money coming in. The owners of commercial property must either deal with tenant problems and complaints, or hire a property manager to do so; manage the debt; and pay for insurance. In addition, particularly in this economy, there is a potential that the lessee may be forced to shut down his business and vacate the premises.

If you are waiting to buy real estate until the economic situation turns around, it is still possible to become a player in the industry. By lending on commercial real estate, you can realize the advantages of owning property without the headaches.