Cash is King to your Commercial Mortgage Lender.
In a recent post entitled Value Optimization. What Are Your Considerations?, I suggested that “Cash is King” and your ability to secure optimal financing terms, is tied to your ability to optimize income.
There is a reason why we call it Income Property! Income producing real estate typically involves a landlord (that’s you), and tenant relationship. Your tenant will pay periodic (often monthly) income for the privilege of carrying on business, or residing in your building. This income, less any expenses you may be responsible for, provides all important cash flow.
Why is this important? Because the “economics” of your property is the key consideration for your lender and forms the basis of their determination as to whether, and how much, they will lend to you.
Cash Flow Lenders
Most lenders are “cash flow” lenders. This means that the most important consideration is not building value per se, but the building’s actual income generating ability. Your building’s income generating capabilities are important, and speaks directly to the building’s potential. This may have been a significant factor in your decision to acquire the asset in the first place. You are an entrepreneurial investor who sees an opportunity to create value. That’s great, and one day you will capitalize on that vision. Right now however, that inherent or future value is not as important to your lender as the building’s present ability to “cash flow” positively, and service your debt (pay your mortgage).
Securing Your Full Loan
You may be purchasing a building in an area where other similar properties are selling for, say $400 per sq. ft. Intuitively you think securing a “full loan” (typically a 75% loan to value credit facility) is a “walk in the park”, right? Not so, if your property income will only service a debt of say $200 per sq. ft. You may need to secure additional (and perhaps more expensive) debt, inject more equity, or simply set your sights lower.
What’s the take-away here? Value is often a perception of future reality. “Value-Add” buyers will need to be mindful of that, when seeking mortgage financing from cash flow lenders. Remember, Cash is King!