Nevada’s commercial real estate industry is growing again. New projects are underway, both sales of existing buildings and those under construction.
“We’re definitely seeing a large increase in our loan volume over the last several months,” said Debra Alexandre, president, Nevada State Development Corp. “It’s looking much better than it has since the recovery began. We’re starting to see a lot more ground-up construction loans, where during the recession and the beginning of the recovery we really weren’t seeing any.”
Today, nearly 50 percent of new loan volume is construction or major improvements loans. Owner-occupied buildings, whether built or purchased, are growing in number with probably more than 50 percent of financing involved with the owner-occupied real estate, according to Scott Aney, senior vice president and commercial banking services manager, City National Bank.
As Nevada experiences a growth spurt in commercial real estate projects, there are many ways to finance those projects and many willing lenders.
Best Practices in Finding Financing
Projects begin with financing and financing begins with people.
Start with market research, said Bradley Beal, president/CEO, One Nevada Credit Union. “Talk to several lenders and call around. Maybe talk to some commercial real estate brokers, they have some good ideas about who’s lending and how to go about achieving financing.” Shop around, compare pricing, terms, and conditions of loans.
For Nevada State Bank, the process starts with an initial meeting between the borrower and bank representative. The bank needs specific information in order to structure financing.
“We’re looking for a well-located project with supportable market demand and we look at [the borrower] financially, is he an experienced developer or an investor with a good reputation in the market and someone we’ve done business with before,” said Jeff Jenkins, executive vice president, statewide real estate lending manager, Nevada State Bank.
“Most people start with their individual bank,” said Alexandre. “But there are plenty of options out there.” Nevada State Development Corp is a certified development company chartered by the Small Business Administration (SBA) to package, process, and service SBA loans. Borrowers looking at such loans need to understand their businesses thoroughly and have up-to-date financial information.
For general small business loans, there are standard, conventional bank products. SBA offers several products banks can use for small businesses in addition to SBA 504, which provides financing at below market rates and is popular for owner-occupied projects. For borrowers not looking for real estate or long-term fixed assets, SBA can guarantee a bank loan through the 7A program.
That’s the tip of the financing iceberg.
Financing for owner-occupied buildings is generally traditional financing with high advance rates and aggressive financing.
“We underwrite the business and the business itself should have a history of profitability in the amount to make rent payments and has to have market value to sustain it,” said Aney. The loan needs to not be above 80 percent of what the value is, but primarily the bank looks at the strength of the company.
“What’s different today than it was three or four years ago is that we’re seeing the consistent profitability of operating companies and businesses,” said Aney.
Investor real estate is also popular, where individuals invest in construction projects or occupied buildings where tenants generate income for them.
Construction loans differ from loans for existing buildings in how they’re financed and what kind of lender finances what kind of project.
“Construction loans require a greater due diligence with respect to that developer and how will they complete a project, are they a seasoned developer, is the type of project they’re trying to build one they have a reputation of being able to build on time and within budget. We need a detailed market analysis that proves the viability of the proposed project,” said Jenkins.
Financing decisions for existing properties rely heavily on the historical leasing or operating data of the property, coupled with market performance and the amount of demand for the type of property. Banks consider whether the borrower has a good professional team of accountants and attorneys in place. With construction projects, lenders also look at the contractors financial position and determine if the borrower can support the size of the loan they’re seeking.
“And it may seem obvious,” Aney said, “but the more extra liquidity you have, the greater the chances of success.”
Traditional commercial banks lend off existing programs, said Kyle Nagy, founder/director, CommCap Advisors. “A commercial mortgage lending firm represents several different types of the lender, several different programs, in-state and out-of-state lending sources like life insurance companies, commercial mortgage bank security lenders, pension funds and also regional and national banks.”
Life insurance companies can become involved in conduit financing, aligning their portfolios with real estate brokers who can help them house their cash in long-term assets that match the insurance company’s long-term policies. Conduit financing mostly dried up in Nevada during the downturn and is only just returning.
So what’s the best commercial real estate financing?
“Individual buyers have their own specific circumstances. The best thing for them is to try to match up their lender’s terms and conditions, and provisions of the loan to their own personal preferences,” said Beal.
For example, many borrowers prefer to have no prepayment penalty so, if they want to sell the property within two or three years of purchase, they can, without penalty.
But lenders who don’t have prepayment penalty clauses may require personal guarantees (recourse loans). Borrowers need to decide whether not having a prepayment penalty or not having a resource is more important to them.
“If the property is stabilized, performing, then the majority of borrowers today prefer non-recourse, long-term, fixed-rate institutional loans,” said Nagy.
Non-recourse loans don’t require personal guarantees and the loans are long-term, typically more than 10 years. Most local banks are likely to have three, five or seven-year loans, or sometimes 10 years, said Nagy. Most borrowers also prefer fixed-rate for the entire loan, with the rate locked at application.
Lenders differ in their requirements for background and financial information and place their own emphasis on what’s more important: person or project. Some are driven by the historical performance of business or borrower, others by performance to date of the property the borrower wants to finance.
Long-term fixed-rate non-recourse loans, Nagy mentioned, mean the majority of financing CommCap finds for borrowers is for stabilized properties. A 90,000-square-foot shopping center that’s 90 percent leased with a stable occupancy and good location would be a strong contender for financing. “We’re looking for good collateral, a good borrower, and a stabilized property,” said Nagy.
“We look at whether the property is generating sufficient cash flow to cover the operating expenses and the debt service and how much additional cash flow [they have]. We like to see a little bit of margin above the debt service and operating expenses,” said Beal. “We also like to put in a little allowance for the vacancy if it’s a multi-tenant property.”
So when One Nevada considers lending for existing properties, criteria include how easily the property can be kept occupied, whether the location is good for tenants and business owners find it attractive or if it will be difficult to keep filled.
Construction loans require expertise on the side of the lender, the borrower, the developer and the construction companies involved. It’s a riskier proposition because it’s harder to anticipate occupancy before the building is complete unless it will be owner-occupied.
Just because there are pathways to financing doesn’t mean a project will get financed. After the free-flowing financing that proceeded the recession many wonders, how hard is it to actually get a loan?
In reality, while there may have been some speculative lending prior to the recession in commercial real estate, most of the lending that made the news was residential. Lenders working in commercial real estate didn’t change their practices before or during the recession.
“We haven’t changed that much,” said Stan Wilmoth, president, Heritage Bank of Nevada. “If [the borrower] has a good plan and good tenants, we’ve been making loans all along, 2005 through today. We didn’t slow down more than the economy slowed down.”
Underwriting didn’t change with the recession; borrowers did. “The Great Recession took a toll on the profitability of the borrowers. So the banks didn’t change the way they lent, but the ability of the borrowers changed. It’s easier and there are more opportunities to borrow today – the bank is saying yes to a larger percentage of applications than it did four years ago,” said Aney.
“The commercial financing market right now is very, very competitive,” said Beal. “Projects that are creditworthy will very likely have multiple lenders willing to extend credit to them. I would say it’s much easier [to get financing] given the market’s recovery and rebound and the recovery of real estate values.”
What’s Beyond the Basics?
For one, there are hard money lenders. Though many left Nevada during the recession, some are now returning.
“These are lenders that require high-interest rates, usually north of 8 percent, some in the 10, 11, 12 percent range. These really bridge loans for the short term,” said Nagy.
Borrowers who want to finance an unstabilized project or one that may become unstabilized, borrowers with credit issues like foreclosures or bankruptcies that make it harder to obtain financing from a traditional lender or borrowers who need to move faster to close than a traditional lender can move may choose to work with a hard money lender.
Issues like insufficient cash flow and poor credit history can make obtaining financing challenges, “I will say, on the front end, all lenders try their best to make a loan work before rejecting it,” said Alexandre.
If lenders all say no, what options does a borrower have left? For borrowers with credit adversely affected by the recession, time is the healer, said Wilmoth. Limited solutions in addition to time include SBA 504 or 7A.
“We’re one of the largest 504 lenders in the state and we like that product because it gives customers different solutions to different problems,” said Wilmoth.
If lenders do say no, “It might not be an overall decline,” said Alexandre. “A lender may tell someone what they’re looking for maybe a little more than they can afford and they may want to scale down their project a little bit.”
Financing hasn’t returned to the free flow of capital that existed prior to the recession, Nagy said. “It’s still tighter than it was, but that was also a historical level of capital to the marketplace. During the lending frenzy, money was inexpensive, there were too many lenders and it was an unsustainable path we were on prior to the recession.”
Keys to Success
When it comes to securing a loan, “a lot of it has to do with property type, loan to value, occupancy, performance – it’s not necessarily the individual. In a non-recourse loan that’s real estate, the only collateral is property,” explained Nagy. Recourse bank loans have the property as collateral and can seek repayment from the individual borrower.
With non-recourse institutional loans, the successfully financed project is one that performs well in the marketplace, has reasonable loan-to-value, reasonable price per square foot and favorable occupancy. Determining the ability to finance the project, the banker looks at the property and then, if those items match up, requests information from the borrower about anything that will reflect negatively on the property like foreclosures or bankruptcies.
“In our financing world, you look at the property first and the borrower second,” said Nagy. Banks are the opposite: they start with financials, tax returns, contingent liabilities and collateral available to pledge.
“Our loan volume in dollars is up significantly and that is really a reflection of property values coming back,” said Alexandre. “Higher values and higher prices mean higher dollar loan amounts. Overall, this is the best year we’ve seen since prior to the recession.”
“We have not been this excited about the Las Vegas economy in a long time,” added Aney. “This year has been a good year, it’s what we expected. There’s been a lot of growth opportunities and it’s great to see cranes in the sky again.”