As a general rule, the conduit market underwrites loans to a maximum 75 percent loan-to-value (LTV) using the trailing 12 months of cash flow, not including alternate sources of income such as late fees, interest income and RV-storage income. A property in lease-up may have stabilized occupancy today (85 percent to 95 percent), but may not have had enough cash flow over the past 12 months to qualify for higher LTV requests.
The following are underwriting guidelines to follow when assessing whether your property may qualify for conduit financing:
- Determine your effective gross income (EGI) by adding your gross scheduled income (GSI) with all other income sources (such as merchandise, vending, RV storage and auction income) and subtracting a 10 percent vacancy factor (used in most cases).
GSI + other income - 10 percent vacancy factor = EGI
- From your EGI, deduct your operating expenses, including new real estate taxes if applicable. If outside management fees are not included in your operating expenses, deduct 5 percent of your EGI to cover this. Also deduct 15 cents per square foot for future-replacement reserves (replacement of roofs, exterior paint, etc.). This is your net operating income (NOI).
EGI - operating expenses - $0.15/square foot = NOI
- Divide your NOI by your annual debt service (principle and interest based on desired loan amount and terms). This is your debt-coverage ratio (DCR). Generally, a 1.30 minimum DCR is required to qualify for conduit financing.
While conduit loans offer very low fixed rates and are generally nonrecourse, they do carry several disadvantages for investors. These loans typically have stiff prepayment penalties tied to yield maintenance or defeasance, which can easily run six figures in the wrong interest-rate environment. They also generally impound for taxes, insurance and future-replacement reserves, and require a minimum of $3 million to $5 million in insurance-liability coverage.
The costs to obtain these loans will run between $10,000 to $30,000, depending on the lender and whether you choose the large ($2 million-plus) or small (typically $500,000 to $2 million) loan program. (This does not include the 1 percent loan- origination fee at closing.) Most conduit lenders charge an upfront, nonrefundable application fee of anywhere from $2,500 to $5,000 in addition to the third-party report deposit. The report will cover the appraisal, phase-one environmental site assessment and property condition, and typically runs about $15,000. Lenders also generally require an ALTA (American Land Title Association) survey, which can easily cost between $5,000 and $7,000. Under the large loan program, you will also usually incur lender's legal fees, which can fall between $7,000 and $10,000.
The above fees are usually less under the small loan program and are typically capped around $10,000 to $12,000, not including the ALTA survey. There are probably a dozen or more active conduit lenders, all having their own specific requirements. One lender may not have any legal fees and no need for a survey in some cases, but might be more conservative in loan dollars. Another lender may be more expensive, but will stretch the loan dollars. The key is to find the lender that most closely matches your investment strategy. Your mortgage bankers and brokers can be helpful in this area.
Is It Worth It?
All this being said, a 10-, 15- or 20-year term at fixed rates far below 8 percent can well be worth the upfront costs for long-term holders of property. Ten-year loans carry up to a 25-year amortization, while periods exceeding 10 years are generally self-amortizing (i.e., a 15-year fixed-rate loan will have a 15-year amortization). Many lenders limit the amortization on metal buildings to 20 years vs. 25. Most conduit lenders prefer stable, well-located properties in metropolitan or high-traffic areas and construction of concrete block, brick or wood frame. Two-story facilities are generally not preferred unless drive-up access is provided. It takes about 60 days to close a conduit loan.
While borrowers can go directly to many of the conduit lenders to originate a loan without the use of a mortgage banker or broker, the process can be a difficult one and is filled with lots of paperwork and red tape. It is highly recommended you understand the loan terms, closing requirements (insurance, title endorsements, etc.) and checklists of information. You should even try to get a sample copy of the conduit lender's loan documents before laying out the upfront cash to begin the process. An experienced banker/broker can guide you through the process and let you know what to expect.
For those looking for lower loan costs and easier prepayment schedules, many other programs are provided by banks, savings and loans, thrifts and even credit unions. There are a handful of national banks offering 10-year, fixed-rate financing at rates around 7.5 percent to 8 percent. These terms can include a full, 10-year or two consecutive five-year fixed-rate periods. Some also offer fully amortized 15-year fixed rates. There are also adjustable-rate programs available in the low 7 percent range. Most of these lenders have upfront fees around $1,000 to $2,500, plus appraisal and environmental fees. The legal fees, if any, are usually around $2,500. Generally, no surveys are required.
Other financing options may require some good, old-fashioned due diligence. For loan requests under $1 million, local and regional, small to mid-size, commercial and community banks may offer acceptable financing terms; but don't overlook savings and loans, thrifts and credit unions as an alternative to your current banking relationships. Yes, even credit unions are starting to offer commercial financing--and most with no prepayment penalties.
For example, in Southern California, we have at least three different credit unions offering commercial financing options. These options range from one program that offers a 6.5 percent fixed rate for two years, then rolls into an 8-year adjustable rate, to another that offers a 20-year fixed rate with a 30-year amortization at 8.375 percent. Both programs have no prepayment penalty.
Permanent loans of more than $1 million are best left for the conduit lenders, insurance companies and larger banks. Insurance-company lending is similar to conduit lending, but with easier underwriting criteria and less paperwork. However, insurance companies are much more conservative in loan dollars, preferring a 65 percent to 70 percent maximum LTV. In addition, properties must generally be well-occupied, newer, well-located and of nonmetal construction. They are selective and prefer shorter, self-amortizing loans. Finally, they typically offer upfront rate-lock features, whereas the conduit lenders prefer to offer rate locks after the loan commitment (two weeks prior to closing).
Be proactive in your financing search by starting early. Lenders are very busy in the current interest-rate environment and closing times are lengthening. Don't wait until 60 days prior to current loan maturity. Give yourself at least 90 days to search for and procure the loan program best suited to your needs.
David Smyle is a 12-year veteran of the banking industry and a mortgage banker in La Mesa, Calif. His company, Benchmark Financial, offers financing solutions for self-storage, apartment and commercial properties nationwide through its direct lending relationship with Bond Street Capital and other institutional financing sources. For more information, call 877.862.7916; email [email protected] ; visit www.benchmarkfin.com