Your commercial real estate transaction does not close unless the loan is approved. You can also improve the cash flow if the interest rate for the loan is low. So the more you know about commercial loans, the better decision you can make about your commercial real estate investment.Loan Qualification: Most of you have applied for a residential loan and are familiar with the process. You provide to the lender with:
W2′s and/or tax returns so it can verify your income,

Bank and/or brokerage statements so it can verify your liquid assets and down payment.
In general the more personal income you make the higher loan amount you qualify. You could even borrow 95% of the purchase price for 1-unit principal residence with sufficient income.For commercial loan, the loan amount a lender will approve is based primarily on the net operating income (NOI) of the property, not your personal income. This is the fundamental difference between residential and commercial loan qualification. Therefore, if you buy a vacant commercial building, you will have difficult time getting the loan approved since the property has no rental income. However, if you
Occupy at least 51% of the space for your business; you can apply for SBA loan.

Have sufficient income from another commercial property used as cross collateral; there are lenders out there that want your business.
Loan to Value: Commercial lenders tend to be more conservative about the loan to value (LTV). Lenders will only loan you the amount such that the ratio of NOI to mortgage payment for the loan, called Debt Coverage Ratio (DCR) or Debt Service Ratio (DSR) must be at least 1.25 or higher. This means the NOI has to be at least 25% more than the mortgage payment. In other words, the loan amount is such that you will have positive cash flow equal to at least 25% of the mortgage payment. So, if you purchase a property with low cap rate, you will need a higher down payment to meet lender’s DCR. For example, properties in California with 5% cap often require 50% or more down payment. To make the matter more complicated, some lenders advertise 1.25% DCR but underwrite the loan with interest rate 2%-3% higher than the note rate! Since the financial meltdown of 2007, most commercial lenders prefer keeping the LTV at 70% or less. Higher LTV is possible for high-quality properties with strong national tenants, e.g. Walgreens or in the areas that the lenders are very familiar and comfortable with. However, you will rarely see higher than 75% LTV. Commercial real estate is intended for the elite group of investors so there is no such thing as 100% financing.Interest Rate: The interest for commercial is dependent on various factors below:
Loan term: The rate is lower for the shorter 5 years fixed rate than the 10 years fixed rate. It’s very hard to get a loan with fixed rate longer than 10 years unless the property has a long term lease with a credit tenant, e.g. Walgreens. Most lenders offer 20-25 years amortization. Some credit unions use 30 years amortization. For single-tenant properties, lenders may use 10-15 years amortization.

Tenant credit rating: The interest rate for a drugstore occupied by Walgreens is much lower than one with HyVee Drugstore since Walgreens has much stronger S&P rating.

Property type: The interest rate for a single tenant night club building will be higher than multi-tenant retail strip because the risk is higher. When the night club building is foreclosed, it’s much harder to sell or rent it compared to the multi-tenant retail strip. The rate for apartment is lower than shopping strip. To the lenders, everyone needs a roof over their head no matter what, so the rate is lower for apartments.

Age of the property: Loan for newer property will have lower rate than dilapidated one. To the lender the risk factor for older properties is higher, so the rate is higher.

Area: If the property is located in a growing area like Dallas suburbs, the rate would be lower than a similar property located in the rural declining area of Arkansas. This is another reason you should study demographic data of the area before you buy the property.

Your credit history: Similarly to residential loan, if you have good credit history, your rate is lower.

Loan amount: In residential mortgage, if you borrow less money, i.e. a conforming loan, your interest rate will be the lowest. When you borrow more money, i.e. a jumbo or super jumbo loan, your rate will be higher. In commercial mortgage, the reverse is true! If you borrow $200K loan your rate could be 8%. But if you borrow $3M, your rate could be only 4.5%! In a sense, it’s like getting a lower price when you buy an item in large volume at Costco.

The lenders you apply the loan with. Each lender has its own rates. There could be a significant difference in the interest rates. Hard money lenders often have highest interest rates. So you should work with someone specialized on commercial loans to shop for the lowest rates.

Prepayment flexibility: If you want to have the flexibility to prepay the loan then you will have to pay a higher rate. If you agree to keep the loan for the term of the loan, then the rate is lower.
Commercial loans are exempt from various consumers’ laws intended for residential loans. Some lenders use “360/365″ rule in computing mortgage interest. With this rule, the interest rate is based on 360 days a year. However, the interest payment is based on 365 days in a year. In other words, you have to pay an extra 5 days (6 days on leap year) of interest per year. As a result, your actual interest payment is higher than the rate stated in the loan documents because the effective interest rate is higher.Prepayment Penalty: In residential loan, prepayment penalty is often an option. If you don’t want it, you pay higher rate. Most commercial loans have prepayment penalty. The prepayment penalty amount is reduced or stepped down every year. For example on a 5 year fixed rate loan, the prepayment penalty for the first year is 5% of the balance. It’s reduced to 4% and then 3%, 2%, 1% for 2nd, 3rd, 4th and 5th year respectively. For conduit loans, the prepayment amount is huge as you have to pay for the interest between the note rate and the equivalent US Treasure rate for the whole loan balance for the remaining term of the loan. This prepayment penalty is called defeasance or yield maintenance.Loan Fees: In residential mortgage, lenders may offer you a “no points, no costs” option if you pay a higher rate. Such an option is not available in commercial mortgage. You will have to pay between ½ to 1 point loan fee, appraisal cost, environment assessment report fee, and processing/underwriting fee. A lender normally issues to the borrower a Letter of Interest (LOI) if it is interested in lending you the money. The LOI states the loan amount, interest rate, loan term and fees. Once the borrower pays about $5000 for loan application fees for third party reports (appraisal, phase I, survey), the lender starts underwriting the loan. It orders its own appraisal using its own pre-approved MAI (Member of Appraisal Institute) appraisers. If the lender approves the loan and you do not accept it, then the lender keeps all the fees.Loan Types: While there are various commercial loan types, most investors often encounter 3 main types of commercial loans:1. Small Business Administration or SBA loan. This is a government guaranteed loan intended for owner-occupied properties. When you occupy 51% or more of the space in the building (gas station or hotel is considered an owner-occupied property), you are qualified for this program. The key benefit is you can borrow up to 90% of purchased price.2. Portfolio loan. This is the type of commercial loans in which the lenders use their own money and keep on its balance sheet until maturity. Lenders are often more flexible because it’s their money. For example East West Bank, US Bank and some life insurance companies are portfolio lenders. These lenders require the borrowers to provide a personal guaranty for the payment of the loans. And thus these loans are recourse loans.3. Conduit loan or CMBS (Commercial Mortgage-Backed Securities) loan. This was a very popular commercial loan program prior to the 2007 recession where its market size was over $225 Billion in 2007. It was down to just a few Billion in 2009 and is making a comeback with issuance of almost $100 Billion in 2015. Many individual loans of different sizes, at different locations are pooled together, rated from Triple-A (Investment grade) to B (Junk) and then sold to investors over the world as bonds. Therefore it’s not possible to prepay the loan because it’s already part of a bond. These are the characteristics of conduit loans:
The rate is often lower. It is often around 1.2% over the 5 or 10 year US Treasury rates compared to 1.85-3% over the 5 or 10 year US Treasury rates for portfolio loan. Some CMBS loans have interest only payments. Since the rate is lower and borrowers are required to pay interest only, the LTV can be over 75%. Low rates and high LTV are the key advantage of conduit loan.

Conduit lenders only consider big loan amount, e.g. at least $2M.

Lenders require borrower to form a single-asset entity, e.g. Limited Liability Company (LLC) to take title to the property. This is intended to shield the property from other the borrower’s liabilities.

The loans are non-recourse which means the property is the only collateral for the loan and the borrowers do not have to sign personal guaranty. And so these loans are popular among investment firms, REIT (Real Estate Investment Trust), TIC (Tenants in Common) companies that invest in commercial real estate using funds pooled from various investors.

If the borrower later wants to sell the property before the loan matures, the new buyer must assume the loan as the seller cannot pay off the loan. This makes it harder to sell the property because the buyer needs to come up with a significant amount of cash for the difference between the purchase price and loan balance. Furthermore, the lender/loan servicer could reject the loan assumption application for various reasons as there are no strong incentives for it to do so. The loan servicer can also impose new conditions to loan assumption approval, e.g. increase reserve amount by several hundred thousand dollars. If you are a 1031-exchange buyer, you may want to think twice about buying a property with loan assumptions. Should the lender reject your loan assumption application, you may end up not qualifying for the 1031 exchange and be liable for paying capital gain. This is the hidden cost of conduit loan.

Even when you are allowed to prepay the loan, it costs an arm and a leg if you want to prepay the loan. The prepayment penalty is often called Defeasance or Yield Maintenance. Basically you have to pay the difference in interest between the note rate of your loan and the applicable US Treasury rate for the remaining years of the loan! This amount is often so high that the seller normally requires the buyer to assume the loan. You can compute the defeasance from www.defeasewithease.com website. Besides the defeasance, you also have to pay 1% loan assumption fee. This is another hidden cost of conduit loan.
Conduit loan may be the loan for you if you intend to keep the loan for the life of the loan that you agree to at the beginning. Otherwise it could be very costly due to its payoff inflexibility.Lenders Coverage Area: Commercial lenders would do business in areas they are familiar with or have local offices. For example East West Bank will only consider properties in California. Many commercial lenders don’t lend to out-of-state investors.Lenders Coverage Property Types: Most commercial lenders would only consider certain types of properties they are familiar with. For example Chase would do apartments and owner-occupied office buildings but not retail properties or gas stations. Westford Financial specializes on church financing. Comerica concentrates on owner-occupied properties.Lenders Escrow Accounts: Most lenders require borrowers to pay 1/12 of property taxes each month. Some lenders require borrowers to have repairs and/or TI (Tenants Improvement) reserve account to make sure the borrowers have sufficient funds to cover major repairs or leasing expenses should existing tenants not renew the leases.Conclusion: Commercial loans are a lot more complex and difficult to obtain with loan approvals more unpredictable than residential loans. As an investor, it is in your best interest to employ a professional commercial loan broker to assist with your commercial loan needs. By doing so, you will vastly improve your chances of paying lower interest rates, avoid potential pitfalls and improve your chance on getting the loan approved.

What if something happens to you, and you can no longer manage your business anymore? Who will then take over your business, and will it be managed the way you want?Establishing a sound business succession plan helps ensure that your business gets handed over more smoothly.Business succession planning, also known as business continuation planning, is about planning for the continuation of the business after the departure of a business owner. A clearly articulated business succession plan specifies what happens upon events such as the retirement, death or disability of the owner.A good business succession plans typically include, but not limited to:·Goal articulation, such as who will be authorized to own and run the business;The business owner’s retirement planning, disability planning and estate planning;·Process articulation, such as whom to transfer shares to, and how to do it, and how the transferee is to fund the transfer;·Analysing if existing life insurance and investments are in place to provide funds to facilitate ownership transfer. If no, how are the gaps to be filled;·Analysing shareholder agreements; and·Assessing the business environment and strategy, management capabilities and shortfalls, corporate structure.Why should business owners consider business succession planning?·The business can be transferred more smoothly as possible obstacles have been anticipated and addressed·Income for the business owner through insurance policies, e.g. ongoing income for disabled or critically ill business owner, or income source for family of deceased business owner·Reduced probability of forced liquidation of the business due to sudden death or permanent disability of business ownerFor certain components of a good business succession plan to work, funding is required. Some common ways of funding a succession plan include investments, internal reserves and bank loans.However, insurance is generally preferred as it is the most effective solution and the least expensive one compared to the other options.Life and disability insurance on each owner ensure that some financial risk is transferred to an insurance company in the event that one of the owners passes on. The proceeds will be used to buy out the deceased owner’s business share.Owners may choose their preferred ownership of the insurance policies via any of the two arrangements, “cross-purchase agreement” or “entity-purchase agreement”.Cross-Purchase AgreementIn a cross-purchase agreement, co-owners will buy and own a policy on each other. When an owner dies, their policy proceeds would be paid out to the surviving owners, who will use the proceeds to buy the departing owner’s business share at a previously agreed-on price.However, this type of agreement has its limitations. A key one is, in a business with a large number of co-owners (10 or more), it is somewhat impractical for each owner to maintain separate policies on each other. The cost of each policy may differ due to a huge disparity between owners’ age, resulting in inequity.In this instance, an entity-purchase agreement is often preferred.Entity-Purchase AgreementIn an entity-purchase agreement, the business itself purchases a single policy on each owner, becoming both the policy owner and beneficiary. When an owner dies, the business will use the policy proceeds to buy the deceased owner’s business share. All costs are absorbed by the business and equity is maintained among the co-owners.What Happens Without a Business Succession Plan?Your business may suffer grave consequences without a proper business succession plan in the event of an unexpected death or a permanent disability.Without a business succession plan in place, these scenarios might happen.If the business is shared among business owners, then the remaining owners may fight over the shares of the departing business owner or over the percentage of the business.There could also be a potential dispute between the sellers and buyers of the business. For e.g., the buyer may insist on a lower price against the seller’s higher price.In the event of the permanent disability or critical illness of the business owner, the operations of the company could be affected as they might not be able to work. This could affect clients’ faith, revenue and morale in the company as well.The stream of income to the owner’s family will be cut off if the business owner, being the sole breadwinner of the family, unexpectedly passes away.Don’t let all the business you have built up collapse the moment you are not there. Planning ahead with a proper business succession plan before an unexpected or premature event happens can help secure your business legacy, ensuring that you and your family’s future will be well taken care of.

“An expert is someone who lives more than 50 miles out of town
and wears a tie to work.”
- Bryce’s LawINTRODUCTIONThe need for outside contract services is nothing new. IT-related
consultants have been around since the computer was first introduced for
commercial purposes. Today, all of the Fortune 1000 companies have consultants
playing different roles in IT, either on-site or offshore. Many companies are
satisfied with the work produced by their consultants, others are not. Some
consultants are considered a necessary evil who tackle assignments
in an unbridled manner and charge exorbitant rates. For this type of
consultant, it is not uncommon for the customer to be left in the dark
in terms of what the consultant has done, where they are going, and if
and when they will ever complete their assignment. Understand this, the
chaos brought on by such consultants are your own doing.IT consultants offer three types of services:
Special expertise – representing skills and proficiencies your
company is currently without, be it the knowledge of a particular
product, industry, software, management techniques, special
programming techniques and languages, computer hardware, etc.

Extra resources – for those assignments where in-house
resource allocations are either unavailable or in short supply,
it is often better to tap outside resources to perform the work.

Offer advice – to get a fresh perspective on a problem, it
is sometimes beneficial to bring in an outsider to give an
objective opinion on how to proceed. A different set of eyes
can often see something we may have overlooked.

Whatever purpose we wish to use a consultant for, it is important
to manage them even before they are hired. This means a company
should know precisely what it wants before hiring a consultant.ASSIGNMENT DEFINITIONBefore we contact a consultant, let’s begin by defining the
assignment as concisely and accurately as possible; frankly,
it shouldn’t be much different than writing a job description
for in-house employees. It should include:
Scope – specifying the boundaries of the work
assignment and detailing what is to be produced. This
should also include where the work is to be performed
(on-site, off-site, both) and time frame for performing
the work.

Duties and Responsibilities – specifying the types of
work to be performed.

Required Skills and Proficiencies – specifying the
knowledge or experience required to perform the work.

Administrative Relationships – specifying who the
consultant is to report to and who they will work with
(internal employees and other external consultants).

Methodology considerations – specifying the methodology,
techniques and tools to be used, along with the deliverables
to be produced and review points. This is a critical
consideration in managing the consultant. However, if
the consultant is to use his/her own methodology, the
customer should understand how it works and the deliverables
produced.

Miscellaneous in-house standards – depending on the company,
it may be necessary to review applicable corporate policies,
e.g., travel expenses, dress code, attendance, behavior, drug test, etc.

Many would say such an Assignment Definition is overkill. Far from
it. How can we manage anyone if we do not establish the rules of the
game first? Doing your homework now will pay dividends later when
trying to manage the consultant. Assignment clarity benefits both
the customer and the consultant alike. Such specificity eliminates
vague areas and materially assists the consultant in quoting a price.SELECTING A CONSULTANTArmed with an Assignment Definition, we can now begin the
process of selecting a consultant in essentially the same manner
as selecting an in-house employee. Choosing the right consultant is
as important a task as the work to be performed. As such, candidates
must be able to demonstrate their expertise for the assignment. Certification
and/or in-house testing are good ways for checking required skills
and proficiencies. Also, reviewing prior consulting assignments (and
checking references) is very helpful. Examining credentials is
imperative in an industry lacking standards. For example, many
consultants may have a fancy title and profess to be noted experts in
their field but, in reality, may be nothing more than contract
programmers. In other words, beware of wolves in sheep’s clothing.Ideally, a consultant should have both a business and technical
background. True, technical expertise is needed to perform IT
assignments, but a basic understanding of business (particularly your
business) is also important for the consultant to adapt to your
environment. This is needed even if you are using nothing more than
contract programmers.In terms of remuneration, you normally have two options: an hourly
rate or a fixed price. For the former, be sure the work hours are
specified, including on-site and off-site. Many clients are
uncomfortable paying an hourly wage for an off-site consultant. Under
this scenario, routine status reports should be required to itemize
the work performed and the time spent. However, the lion’s share of
consulting services are based on a fixed price contract. Here, the
role of the methodology becomes rather important. Whether you are
using “PRIDE” or another Brand X methodology, it is important the consultant
and client both have a clear understanding of the project’s work
breakdown structure, the deliverables to be produced, and the review
points. From this, an effective dialog can be communicated in terms
of managing the project. Further, the methodology becomes the basis
for the preparation of estimates and schedules.After examining your candidates, it now becomes necessary to
balance the level of expertise against price. Sure, a senior
person can probably get the job done in less time, but perhaps
the costs may be too high for your budget. “Expertise” versus
“expense” becomes a serious consideration at this point.Whomever is selected, it is important that a written agreement
be prepared and signed. The agreement should reference the Assignment
Definition mentioned above and any other pertinent corporate
verbiage. Very important: make sure it is clear that the work
produced by the consultant becomes your exclusive property (not the
consultant’s). Further, the consultant shouldn’t use misappropriated
work from other assignments. Finally, add a clause pertaining to
workmanship; that the consultant will correct at his/her expense
any defects found; e.g., defective software, data base designs, etc.MANAGING THE CONSULTANTThe two most obvious ways to manage consultants is by having
them prepare routine status reports and project time reports. Such
reports should be produced on a weekly basis and detail what the
consultant has produced for the past week and detail his/her
plans for the coming week. You, the client, should review and
approve all such reports and file accordingly.A methodology materially assists in tracking a consultant’s
progress. As a roadmap for a project, the methodology takes the
guesswork out of what is to be produced and when. Without
such a roadmap, you are at the mercy of the consultant. Along
these lines, I am reminded of a story of a large manufacturing
company in the UK who used one of the large CPA firms to
tackle a major system development assignment. The system was
very important to the client, but lacking the necessary in-house
resources to develop it, they turned to the CPA firm to design and
develop it. Regrettably, the client didn’t take the time
to define the methodology for the project and left it to the
discretion of the CPA firm. The project began and the CPA
firm brought on-site many junior staff members to perform
the systems and programming work. So far, so good. However,
considerable time went by before the client asked the senior partner
about the status of the project (after several monthly invoices). The
senior partner assured the client that all was well and the
project was progressing smoothly. More time past (and more
invoices paid) with still nothing to show for it. Becoming
quite anxious, the client began to badger the consultant as
to when the project would be completed. Finally, after several
months of stalling, the consultant proudly proclaimed “Today
we finished Phase 1….but now we have to move on to Phase
2.” And, as you can imagine, there were many more succeeding
phases with no end in sight.What is the lesson from this story? Without a methodology roadmap,
it is next to impossible to effectively manage a consultant. The
project will lose direction almost immediately and the project will
go into a tailspin. The only person who wins in this regard
is the consultant who is being paid regardless of what work
is produced. Instead of vague generalities, you, the client,
have to learn to manage by deliverables.CONCLUSIONMy single most important recommendation to anyone considering
the use of outside consultants is simple: Get everything in
writing! Clearly define the work assignment, get a signed
agreement spelling out the terms of the assignment, and
demand regular status reports.I am always amazed how companies give consulting firms
carte blanche to perform project work as they see fit. Abdicating
total control to a consultant is not only irresponsible, it is
highly suspicious and may represent collusion and kickbacks.There is nothing magical in managing consultants. It requires
nothing more than simple planning, organization, and control. If you
are not willing to do this, then do not be surprised with the results
produced. Failure to manage a consultant properly or to adequately
inspect work in progress will produce inadequate results. So, do
yourself (and your company) a favor, do your homework and create a
win-win scenario for both the consultant and yourself.