Today’s post is written by Michael Green, Senior Commercial Loan Originator with Counsel Mortgage Group, LLC. Mike writes monthly on the commercial mortgage market. Check back each month for his commentary.
I recently received a call from a prospective buyer of a small business that included the real estate. He called to inquire about financing for the acquisition – could it be done with 10% down. He had talked with the listing broker/agent for the business, and had been assured he could complete the acquisition utilizing “creative” financing. He was also told that the business had been approved for financing by a lender.
There are many elements that can come into play utilizing creative financing. A couple things you can be assured of: (1) it will be complex – possibly unfamiliar terms and conditions, and (2) it will be expensive, more so than conventional. Often this will include seller participation possibly in a couple ways: a simple (or not so simple) seller carryback note secured by a second deed of trust (mortgage), and/or seller taking an equity participation, in which case you’ll have a partner.
In terms of expense, giving up equity for terms or a partner’s buy-in is usually the most expensive money you can get, although it may not seem so at the time. To run a gauge on this, run a present value discount on the payments you’ll be making as spelled out in the Agreement, or if none is stated, use the Agreement percentage in the proforma for a 5-to-10-year period; for the interest rate use the project growth rate of the business. The finite term should be used if there’s a put provision in the financing Agreement specifying the put term, and the buy-out amount included in the present value calculation. (A “put” is a contract provision that allows the lender to force the buyer to buy back their interest for a specified amount of money and a specified period of time – a type of option.)
Note that in pre-qualifying a business and real estate a lender can only determine the collateral value of the real estate and business assets, and the potential debt service coverage from the historical financials – should be from seller’s tax returns. The more pertinent qualification comes from the buyer who the lender won’t know for pre-qualifying the business. If you’re told the business is pre-qualified for financing, ask to see the pre-qual letter. This should be part of the listing broker’s marketing package. When reading it, be sure to note the contingencies and who authored it, the BDO or the credit manager.
As a mortgage broker, we have several types of credit sources available to us ranging from conventional/traditional to less traditional, government insured to private lenders, primary to hard money lenders, and that in between seldom talked about, the semi-prime lenders. We’re experienced in structuring creative financings, and have lenders who can fund the structures we create.
The CRE mortgage market is much more open, less restricted, and less regulated than you may have experienced with residential financing. There are more opportunities giving you more choices, different terminology, more room for error. When you find a property for potential acquisition, your question shouldn’t be “can I finance it”, but rather “how can I finance it”. Your feasibility study for acquiring, managing, and exiting the property or business should include the feasibility of financing.
Assuming you are not qualified for conventional or traditional financing could be costly, sometimes in ways that are not always obvious.
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