In Part 1 of this series, we discussed what the useful and physical life of a commercial building is, as well as the five stages of a building's life. In this article, we will explore some of the factors that can decrease the physical and useful life of a commercial building. We will also touch on building obsolescence, which can be a major threat to older buildings.
*This is the first in a three-part series on considerations when purchasing older buildings.
Purchasing a building that is 25-years-old or older requires a significant historical investigation and analysis to determine the risks associated with the building. These articles are intended to aid any investor attempting to answer the following questions:
- How do you identify the risks that come with the ownership of an older building?
- What factors can hurt the future net cash flow of an older building?
- How much more economic life is left in the building
- How many years are left that will produce reliable income from the ownership of the building?
- How do you determine the current value of an asset with a shorter economic life?
A building’s “useful life” depends on its previous ownership, intended use, and prior maintenance regime.
Back when we were young, fresh-faced students coming out of school and entering the real world we likely had a basic understanding of investing that was limited to publicly traded stocks. Then, as we matured, we all came to realize that investing in publicly traded stocks was only one of the many ways that we could invest our money in the hopes it would grow. Such options are now more diverse and more available than ever and are no longer the exclusive domain of large investors and financial institutions.
One such investment is commercial real estate. This investment class typically takes significant amounts of capital and historically has been a relatively illiquid investment. Over the years, however, those features have significantly changed, and now there are more ways to invest in commercial real estate than ever before.
But before we discuss the ways you can invest in commercial real estate, it must be emphasized that all investments in commercial real estate are not equal. It stands, as with all efficient markets, the greater the risk, the greater the reward (or loss). Commercial real estate is no different. And those risk profiles have designations that are common among most investment classes: debt and equity.
Have you ever wondered what average commercial real estate (“CRE”) bridge loan interest rates are or why the rates are what they are? I’ll give you the spoiler: the average interest rate is 6.5%. Just kidding. Actually, the answer is: it depends. Boring, right? But it does depend. It depends on things like risk profile, lender appetite, and interest rate trends. We’ll dig a bit deeper and see if we can provide some helpful information on why lenders do what they do and what to expect in a rate.
Topics: Bridge Loans
Securing a commercial bridge loan can be a lot of work and any missteps can prove costly. Below are some tips, that if followed, will increase the probability of obtaining attractive bridge financing.
Have a Defined Plan
It is imperative to have a defined plan with an accompanying budget including a spreadsheet of monthly income and expenses for the first 24 months of the loan period. A lender’s ability to both understand and quantify the strategy quickly always works to the sponsor’s advantage. In particular, ensure that you are thorough in describing why this is a value-add opportunity.
For example, if poor management is to blame, talk through why they are a poor manager (limited experience, minimal properties under management, etc.). Additionally, any insight as to why the current ownership didn’t recognize or address this shortcoming is also helpful. A well-defined strategy, along with supporting details that paint a clear picture, will give significant credibility to the deal up front.
Understand the Timing Required
Events such as a downturn in the economy, a dispute among partners, or cash flow problems caused by new market competition, can affect the viability of an income property loan. These real estate loans may need a “workout” by the lender so that the borrower doesn’t lose its property. During the loan workout phase, it is critical that the borrower keep in full, open communication with the lender about their cash flow situation and plans to avoid a monetary default. When a lender is dealing with a responsible, honest borrower, the lender is more likely to work with the borrower to help them get through a rough period.
With that being said, even if no actual monetary default has occurred, there are a number of events that could precipitate the need for the appointment of an independent receiver. Some examples of these events are:
Bridge loans. You’ve heard about them, you kind of understand what they are, but you’re not clear on the details or if one is right for you? This article will hopefully clear up some of the ambiguity surrounding Commercial Real Estate (“CRE”) bridge loans and answer any unanswered questions.
What is a commercial real estate bridge loan?
A commercial real estate bridge loan typically has a 1-5 year term and is intended to transition an underperforming property into one that has reached full potential. This is achieved through a multiple-advance loan structure that commits money up front to cover the cost of the purchase or refinance, and then future monies for leasing costs and capital expenditures needed to maximize the income generated by the property. That unique structure is what makes a bridge loan.
Would a bridge loan be right for your deal?
You find yourself involved, or at least interested, in purchasing or refinancing commercial property. You’ve made the decision to finance a portion of the investment with debt, and you require a loan, but you don’t need the loan for a long period of time. A bridge loan could be the solution.
Bridge loans have a special place in the commercial real estate finance ecosystem. They exist, as the name suggests, to bridge your investment over a transitional period. There are many reasons commercial real estate borrowers or sponsors look to a bridge loan for their financing needs. Some of them are:
Topics: Bridge Loans
The Rise of a New Asset Class
Since the Great Financial Crisis, the low yield environment, as well as certain regulatory changes, have given rise to a previously lesser-known alternative asset class known as “private credit”. Private credit funds target ownership in debt and debt-like instruments across various segments (corporate, consumer, real estate, litigation, life settlements, royalties, etc.) with the goal of generating high yields, mostly in the form of ordinary income, for their investors.
Catching the Service Provider World Off Guard
As this asset class rose to popularity rather quickly, it seems to have caught the outside service provider world largely unprepared, having a lack of experience on how to manage, account, and administer this new asset class. As a result, most service providers advising private credit managers defaulted to their knowledge of private equity fund formation and administration, resulting in many of these funds being structured like traditional private equity funds.
Here at RRA Capital, we evaluate CRE bridge loan requests every single day. Over the last decade, several common themes have begun to arise, and we’d like to share the top ten missteps that brokers make when trying to secure a bridge loan on behalf of their client.
1. Sloppy/No Package
Only forwarding an OM (offering memorandum) or historical financials without putting together a package typically looks lazy or desperate. The easier it is to cohesively synthesize the information, the better the response will be from the lender. Lenders are ideally looking for concise descriptions of the business plan, pro forma cash flows along with assumptions, sponsor bio, and sources and uses. A lone faxed copy of Q2-2012 cash flows likely won’t solicit a sharp quote.
In the bridge lending universe, the ability to close a loan expeditiously is paramount. Some borrowers are seeking what we term “delayed acquisition financing”, where they have already purchased a property (usually cash) and now want to place debt on the property to free up capital for other projects. These borrowers generally have no time requirement and very little incentive to close quickly. Conversely, other borrowers have a hard impending close on a purchase, the previous lender may have fallen out, and they have two weeks (or less!) to secure financing or they lose the property, and potentially a large deposit to boot. Other situations that require a fast close are a 1031 exchange or if the property was won at auction and the auction contract requires a fast transaction. Whatever the situation, a bridge lender’s capacity to close fast can mean the difference between getting the business or losing it to a firm that can get it done. So in addition to a fast close being important to the borrower, it’s also important to us.
As a lender that recognizes how important this ability is to our borrowers, we have strategies to make sure that we are providing the borrower with all of the tools they need to close on time. This includes scheduling 3rd party inspections immediately (and paying the extra for the expedited turnaround), scheduling a “kick off call” with the lender, borrower, and respective counsels, delivering a detailed list of required due diligence items on day-one, and responding to all items that borrower delivers as soon as possible (while still maintaining the required level of compliance with closing policies).
Despite the fact that we provide our borrowers what they need to close on time, some borrowers choose not to utilize those tools – we’re all adults and that’s their prerogative. However, for those that are concerned with hitting the target, here are what we find to be the most common roadblocks to a speedy closing.