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Letters of Credit. A Tool for both Lenders and Borrowers?

Lines of Credit

Most of us are familiar with Line’s of Credit (“LOC’s”). Often secured against personal assets, your home (hence the term Home Equity Line of Credit, or HELOC), or eligible investments LOC’s are a popular form of credit. They are often granted to supplement a mortgage.

Letters of Credit

A Letter of Credit (“LC”) is an all together different credit product, or tool. It is more prevalent in trade and commercial transactions. They have their place as a tool in commercial mortgage lending as well.

What is it? It’s an issuer’s (often a Bank’s) promise to pay, triggered by the performance (or non-performance) of an obligation. In the commercial real estate realm, LC’s are used between Mortgage Lender and Borrower, and between Landlord and Tenant. As such, they are typically referred to as “Standby” Letters of Credit. The benefit of an LC, to either yourself or your Lender, is that it cannot be revoked by the applicant (the party providing the LC to the beneficiary). The issuing Bank is obligated to honour the Letter of Credit according to its terms, whether or not the applicant is aware or agrees to its presentation to the issuing Bank.

How are they used?

LC’s are used extensively in new real estate development. Often for the purpose of “backstopping” borrower/developer performance. An example would be the requirement that a builder post an LC when developing a subdivision. The City may require the additional provision of certain roadworks, or public amenities, often at the final stages of development. Failure to complete this work by the time stipulated, would allow the Municipality to “cash” the LC, and provide compensation for undertaking this work themselves. Here in Canada, municipalities will often require LC’s to secure the performance of site works which may, due to our climate, be necessary to delay for several months.

As a landlord and prospective mortgage Borrower, you may undertake certain costly improvement works for a start-up tenancy where there is added income risk, say a Restaurant. A tenant’s financial strength is the most critical consideration, when entering into a commercial lease. In such a circumstance an LC is often viewed as better security than cash. This is particularly true where a tenant is at risk of declaring bankruptcy in a possible subsequent business failure. Obtaining a cash settlement in such a situation is inevitably a time consuming and often fruitless exercise. Provide yourself, and your lender, the added comfort that an LC contributes.

Lender’s may require an LC from you to qualify for a particular loan amount. The Commitment may stipulate that you lease your building to a certain occupancy level and income, by a particular date. Your inability to do so may permit the Lender to cash the LC . The Lender could use the proceeds to either reduce the principal balance of your loan, or perhaps to create an interest payment reserve.

What you Need to Know

Whether you are applicant or the beneficiary of an LC, understand that an LC is irrevocable. It is a separate instrument from the underlying contract (e.g. a Lease). If properly drafted, (and there are conventions around this), the Bank must honor the document subject to it being presented properly.

If cashed, the beneficiary can typically do what they wish with the proceeds. The amount of the LC then becomes a credit obligation of the applicant. In other words, if you are the applicant, and the beneficiary draws on the LC, you are now indebted to the Bank that granted the LC.

Seek Legal Advice

Perhaps you are obtaining an LC from a tenant, to backstop their rental performance and provide comfort to your Lender. Do ensure the document is drafted properly. Seek legal advice on the proper format and documentation required. You don’t need to be wondering about your ability to realize on this security, when you need it most!

Understand how an LC works, and whether it may be a useful tool for you.




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Greetings to You

Are you a business man or woman? Are you in any financial mess or do you need funds to start up your own business? Do you need loan to settle your debt, pay off your bills or you need personal loan? We offer all types of loan anywhere you are in the world.

Do you have a low credit score and you are finding it hard to obtain capital loan from local banks/other financial institutes

Alliance Loan Firm is offering an affordable loan scheme at 3.9% percent interest rate without any collateral. (Only identification proof)

Please write us on our email below so we can send you the loan application form and other details you need to know.

Contact E-mail: email@allianceloanuk.com
Alternative Email: michaelneiber4@gmail.com

Note: We will attend to you only when you write to the email.

Regards
Alliance Loan
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Real Estate Experience. 4 Questions your Lender will Ask.

Do you have Real Estate Ownership Experience?

Real Estate financing success depends upon many factors. The income generating capabilities of your property and it's resultant value are important. A well located and well leased property, in good condition, will be attractive physical security for a loan. Underwriting a loan involves more than simply number crunching however. Your Lender wants to know whether you are an experienced Real Estate investor.

Despite the increased use by institutional lenders, of automated decision making tools, commercial real estate financing success revolves around the relationships created between lender and borrower (or broker). A lender can quickly determine whether your requested loan fits within their lending policy guidelines and ratios. What is more challenging for your lender is developing a degree of comfort that you, as a prospective borrower, have real estate experience or expertise, or failing that, sufficient management experience to successfully operate and optimize your real estate holdings.

Your Real Estate Lender will want to know:

1. Do you have Real Estate Ownership and Management Skills?

Ownership and management are complementary but distinct skill-sets. Real estate management generally infers an ability to apply skills to ownership as well. However one can own commercial real estate but have little in the way of real estate management skills.

It's certainly possible to own commercial real estate without hands-on involvement. In fact for commercial real estate assets of substantial size, it makes a lot of sense to hire 3rd party management. A lender will however will derive considerable comfort if you demonstrate your ability to communicate with your property management firm. Your ability to provide direction in a manner that goes beyond simply hiring someone to “take care of the property” speaks volumes.

2. Can you Demonstrate the Ability to Manage Property, or to Direct those who do?

The effective management of commercial real estate involves:

day-to-day oversight,
rent optimization,
expense curtailment,
making capital investments/improvements,
marketing vacant space; and
having on-going positive interaction with tenants.
While some or all of these activities can be delivered by a 3rd party manager, it is advantageous for you to demonstrate your ability to direct strategic decisions and set clear expectations of 3rd party real estate asset managers. A complacent or inactive owner may be either disinterested, or naïve, but in either case this paints a picture to the lender of an individual who is inexperienced and is not optimizing the asset.

3. Can you Communicate your Ownership Strategy?

If employing 3rd party management, Lenders are looking for you to demonstrate the ability to strike a balance between control and management. How can you optimize an asset if you cannot intelligently discuss and communicate (with either their property manager or lender) ownership expectations, leasing strategies, capital expenditure plans, or understand financial reports or lease documentation? For example, why did you/do you want to buy this property? What are your plans for your property? How will you optimize your returns?

In situations of self-management (owner/management), the onus is on you to credibly demonstrate that you have the know-how, coupled with the resources and tools at your disposal to effectively and efficiently management the asset and maximize its potential. One example might be your proficiency with property management software.

4. Can you Demonstrate your Previous Successes?

In situations where you have owned and managed commercial real estate in the past, provide your lender with pertinent details.

where were the properties located?
how long did you own them?
what did you do during your ownership, to maximize property values?
did you realize a profit, if the assets were subsequently sold?
Demonstrate your competence and commitment to successful real estate ownership. It's key to financing success!


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6 Questions for your Lender. It’s about more than just rates!


Inform yourself and make the right decisions!

While interest rates are important, but it is by no means your only consideration. Here are 6 questions to ask your Commercial Mortgage Lender:

1.Does your Bank finance my property type?

Lenders may not have any appetite for your type of property. Why? There may a number of issues at play. Perhaps their hesitation is due to perceived risk in that industry. It could also be that they are re-balancing their loan portfolio, due to a concentration of similar property loans. It may also be as simple as having an unfortunate recent bad experience with a loan(s) in that industry category. Specialty use type properties are often tough to finance. An example might be Self-Storage units. Loans on this type of property have historically experienced low default, but some lenders are completely unfamiliar with the industry. Know this, and don’t waste your time trying to fit a square peg into a round hole.

2. Does your Bank finance properties in my community?

Your lender may not lend in your community. This may be related to perception of risk. It may also relate to geographic concentration of loans within their portfolio. Credit Unions may have policy restrictions on lending only in areas where their members reside. Some larger lenders prefer to lend in communities which have a minimum population threshold.

3. What is your approval process?

This is an important consideration, particularly if your financing is time sensitive. Its great if decisions are made by local personnel at the local Branch or office where you have applied. Additional time is required however, if the loan application needs to be forwarded to a centralized adjudication office, perhaps elsewhere in the Country. Similarly, vetting by a Credit Committee, which may meet infrequently, will delay approval. Loan approvals often take longer than most prospective borrowers believe they will.

4. What additional terms and conditions apply?

Fairly critical to your decision as to which lender to approach, is an understanding of their standard terms and conditions. Will you need to arrange for various 3rd party reports in support of your application, such as an appraisal and environmental report? Do you need to use a lender designated lawyer, or can your lawyer prepare the loan documentation? Will you need to transfer your day to day banking to your new lender? What are the application or processing fees?

5. What features and benefits are available to me?

Different lenders have different product features. If you are financing an apartment building, it may be important to you to have the ability to make mortgage payments on the 5th of the month, after rent cheques clear. Perhaps you would prefer a non-recourse financing offer? Will you have the ability to fix the rate just before closing, or well in advance of closing? Does your lender have that flexibility? Can the lender provide a Line of Credit as part of your mortgage financing? Is there a prepayment privilege, and if so, how is it calculated? Do they offer various lengths of term, length of amortization periods, and a fixed or floating rate option? Any one of these features may be considerably important to you.

6. What are your rates?

Finally, you will want to ensure that your lender’s rates are competitive. How are they determined? Is is based on a spread over their cost of funds, over their residential mortgage rate, or perhaps over the yield on a Government Bond? When is the rate set? Can you buy down the rate?

In conclusion, it is more than just rate! Ask the right questions. Inform yourself. Get the best financing offer available!
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Location and Market. What’s Your Competitive Advantage?

A discussion of your property location and market forms an important part of the loan presentation package for your lender.

This is an opportunity to further describe your property, including:

demographics,
traffic counts,
market conditions (detailed rental rate surveys, or vacancy reports),
household income figures,
as well as a listing of major employers and employment areas.
The amount of information you present depends on the type of real estate being financed. For example, if you are financing a retail development, you will want to emphasize that your property is located in an area where there is a sufficient and perhaps growing population base to support retail tenants; the property is readily accessible and situated on a major thoroughfare; and few, if any competing centres are located in the vicinity.

The following information will be helpful to your lender and relatively straightforward for you to assemble and present:

Is the property on a major thoroughfare, or close to major transportation routes, or transit hubs?
Is the property well served by public transit? How far is the property from downtown, or other important locations within the community?
Are you aware of new or planned developments close to the property and if so how will they impact your property?
Industrial Property

A property location and market discussion for an industrial property will emphasize the advantage of the specific location relative to employment nodes, and transportation routes.

Is the property served by rail? How close is the airport? Is it close to major expressways for ease of truck transport and deliveries? Perhaps the building backs onto a Freeway, providing good visibility for tenant signage?


Multi-Family Residential Property

The focus here should be on the convenience of your location. How close is the property to places of employment, proximity schools, shopping facilities, and other amenities, as well as ease of access to public transit.

Is the location a popular rental area, and why? How does your property compare to similar and competing developments that are either planned or underway?

Is the vacancy rate stable, trending upwards, or downwards?

Perhaps the property located in an established, older area of town. Is it undergoing revitalization?. Is it in a new suburb, surrounded by expanding subdivisions, and well placed to capitalize on future growth in population? Where is the direction of growth headed generally, and will this affect your property?

What are the general market conditions? For example, do vacancies typically lease quickly when units become available? Is there evidence that property owners in your market are reinvesting in their properties by making on-going improvements to their rental properties?

Many of your comments in this section may be based less on factual information, and more on your own opinion or interpretation, however this too is important and useful information and analysis for your lender.


Office Property

In respect of an office development, show your lender that you have given thought to transit availability, and the building’s location relative to established and successful concentrations of office developments.

The lender should also be able to quickly glean what category of office property this is (Class A, B, and C) and how well it competes. A well leased and competitive office building, well located in an established office development node close to public transit, will generate greater lender interest than will an un-competitive, poorly leased office project in a location where no other similar buildings are located.

Discuss general vacancy rates and market trends both to highlight the performance of your property, and to place it in context to neighbourhood/community performance.

Retail Property

The commentary will vary by type of retail property. Storefront retail developments in a central or mid-town location along a heavily traveled artery will offer differing features and attractions to a customer/consumer, than will a large enclosed suburban mall.

Important to any discussion of a retail property will be the type of tenants, the number of units, the availability of parking, and a discussion of the surrounding/supporting customer base.

Does it appear that the consumer base surrounding your property is stable, or growing?
Is your property located in a trendy downtown location undergoing gentrification or infill development?
If located in a middle class suburb, is the location exhibiting stability or growth?
Perhaps your property is located in a newly developed area. Are many young families are moving in?
Though different trends, each one can be highlighted as a supportive and positive attribute for retail real estate.

The Location and Market discussion section allow you to emphasize your property’s competitive advantage. Take the opportunity to reinforce why your property presents an excellent investment opportunity for your lender.


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Cash is King to your Commercial Mortgage Lender.

Optimize Your Income

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!

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Tips for Presenting Your Commercial Mortgage Loan Request

Let’s consider some tips for presenting your commercial mortgage loan request. Begin by understanding that the loan request to your lender involves a series of steps.

First, the initial requirement is for you to clearly indicate the loan amount required. Reference the required term and amortization period you prefer.

Second, you need to clearly articulate the purpose of the funding. It is surprising how many potential borrowers find it difficult to articulate the precise purpose of the requested loan. This is a fundamental aspect of your loan presentation.

Let’s consider the main reasons borrowers apply for a loan:

Purchase Loan

You intend to buy a property? Congratulations! Provide your lender with answers to the following questions:
Purchase price. What are you paying for the property? Provide your lender a copy of the fully executed Agreement of Purchase and Sale.
Amount of equity. How much cash are you injecting? What is the source of the equity? Are you liquidating other assets, or refinancing another property?
Loan to Purchase Price Ratio (loan amount divided by the purchase price).
Amount of Secondary financing if any. Is there a 2nd mortgage? What is the amount? What are the payments? When is it due? This will enable your lender to understand what amount of your own funds are committed to the transaction. As well, it will determine what your total mortgage payments will be.
Purpose of acquisition. Are you a long term investor who intends to hold the property? Are you buying in order to perhaps renovate/re-lease and sell in the short term?
Are repairs and renovations required?
When is the anticipated closing date?
When did the property last transact (sell)? For how much?

Refinance Loan

You intend to pay off another loan? Likely a great strategic move, particularly if current rates are lower. If so, then answer the following questions:
Purpose of refinance request. Is it to refinance an existing loan (maturing debt)? Is it to take out additional (new) money? Are you seeking to lower your interest rate, extend your mortgage term or modify the amortization period? Are you planning to pay for property improvements or renovations?
What is the proposed Loan to Value ratio (loan amount divided by the estimated property value)?
What amount of Equity is there (both originally and now/existing and proposed)? Equity is the amount of cash, or un-financed “value” in the property. If you have a property with an estimated value of $1,000,000, with a $600,000 mortgage balance, your equity is the difference, namely $400,000.
Purpose of funds if equity is being released (i.e. new funds being “drawn out”)?. What will you be spending the new money on?
Cost of repairs and renovations. How much will you be spending, and when?

Construction Loan.

You intend to construct a building? You’ve clearly done your due diligence and determined that constructing a new building is a profitable investment strategy. If so then answer the following questions:
What is the cost of the land?
If land already owned, is it owned free and clear (i.e. paid for and without any mortgage against it)? If not, provide details as to the debt against the land. What was originally paid for the land? When?
What are the construction budget figures?
Who is the contractor?
Is the construction contract in place? Is it fixed-price, or? Your lender will need to know whether costs are fixed, or whether its a cost plus type of contract, or other type. The certainty of costs is important to your lender (and of utmost importance to you as well!).
How much borrower equity (cash) is available? This is not only to determine how much money you have into the project initially, but whether you have the financial resources to handle any cost overruns.
Is the property zoned to allow for the intended use?
Has a building permit and other municipal approvals been obtained?
Has the property been pre-sold or pre-leased? What are the marketing/sales plans, and when do you anticipate securing tenants or a buyer?
What is the estimated “as-completed” value? Have you obtained an appraisal report, estimating the value of the proposed developed as if completed?
How will the construction loan be repaid? When? You need to be able to clearly articulate the exit strategy for your lender?

Bridge Loan

You need a short term loan to make improvements to your property before getting permanent financing. That’s a good plan. You are clearly focused on enhancing the property value. If so then answer the following questions:
What is the purpose of the loan? (i.e. what repositioning is planned? A re-zoning? Building repairs? Re-tenanting? Property conversion?)
When was the property acquired? For how much?
What are the construction cost details and program plan and timing?
What is the Bridge loan exit (repayment) strategy?
Keep in mind that Lenders typically operate within limits regarding Loan to Value ratios. Typically institutional lenders do not exceed a loan to value ratio of more than 75%, and often less. This can differ by property type, geographic location, or other factors.

Be able to clearly articulate the purpose of the requested commercial mortgage loan. It is the key to developing a good working relationship with your lender, as your loan application is being considered!



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