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How Lenders Appraise Commercial Properties

Sep 8, 2008
When considering whether to finance income-producing properties, lenders are especially concerned with the property's stability. They use three primary analytical techniques to determine the property's strength - appraising, underwriting and structuring the loan. To increase your chances of funding income properties, you should be familiar with these three elements of the transaction.


There are many kinds of appraisals and appraisal methods. For the purposes of commercial mortgages, lenders are generally concerned with getting a reasonable estimate of value upon which they can base their loan amount. This estimate not only must be acceptable to the lender, but it also must be acceptable to the many auditors and examiners involved in the transaction.

The information in the appraisal report should be accurate. There should not be unexplained inconsistencies within the paperwork regarding sizes, room counts or any other facets. The appraisal should be logical and based on fact.

The appraisal is always an integral part of an income-property financing submission. Still, mortgage bankers and brokers must exercise good judgment to determine exactly how much importance to give to it.

Indeed, some lending institutions are appraisal-oriented, while others place priority or equal emphasis on other factors such as sponsorship and credit. This does not mean that some lenders accept inadequate appraisals; it merely means that they place less emphasis on the appraisal and more emphasis on other basic fundamentals.


The next analytical technique lenders use with income properties is underwriting. Of all the elements, this is perhaps the most misunderstood and least appreciated in our industry as a whole. It is, however, of paramount importance. We are involved in the business of risk analysis. It is in this area where we find the widest divergence of opinion, appetites and attitudes.

Underwriting involves the melding of specific information on a particular project (physical characteristics, location, appraisal, etc.) with general information on similar projects with which institutions have been associated in the past. This melding of data will help the lender make a decision on whether to make a loan commitment.

Further, the underwriting is the basis for determining the loan's ultimate terms. One lender, for instance, seems perfectly at home with full-documentation loans on shopping centers. Another is willing to consider shopping centers but only so-called prime centers and only on a conservative basis. Some lenders will accept luxury apartments, while others find these types of investment totally unacceptable.

Brokers must intimately know the underwriting patterns of the various lenders. They will vary among properties and among geographic locations, but there are a few factors that will be assessed in almost every type of income property.

These universal considerations include the loan-to-value ratio, the debt-service-coverage ratio, the break-even point, the loan and the income per unit typical of the property type in question. You may also wish to chart, as a routine matter, appropriate area sizes, parking requirements and typical amenities.

Keep alert to the elements of prudent underwriting. It will make it easier to determine what lenders find acceptable with the majority of projects.

Structuring the loan

When it comes to structuring the loan, you have to make a significant judgment concerning the proper amount of financing that a particular property can sustain. The judgment must be based on a thorough analysis of the project's characteristics.

The recommended financing must be attuned to the particular lender with whom you are dealing. If, for instance, the property is a nursing home, and your one nursing home lender has never made a loan in excess of 70 percent of value or has never made a nursing home loan with less than a 1.5 debt-service-coverage ratio, keep those facts firmly in mind when negotiating an application and recommending a particular dollar amount to the lender.

For some borrowers, the aim of financing is not necessarily to arrange for a proper level of financing as much as it is to obtain the highest dollar amount at the lowest rate for the longest term.

On the other side of the fence, however, some lenders believe they should strive for the lowest number of dollars at the highest interest rate for a term that keeps the loan classified as a long-term, permanent loan.

For many of these lenders, the actual amount of the loan is immaterial. Fortunately, there are many members of our industry who aspire to place a proper level of financing upon any income-producing property.

Lenders' levels of interest will vary between types of properties and industries. There are some life-insurance lenders that have had phenomenal success with financing industrial properties or shopping centers or motels and are willing to lend more aggressively in those categories.

Many experienced players in our industry will agree that more projects have failed from overfinancing than from underfinancing, and a lot of people have been driven from our industry because they never acquired the self-discipline to allow projects to stand on their own merits. Older and wiser heads in our industry can recount tale after tale of competent borrowers who began counting on the funds from their next project to bail out a previous one.

Ultimately, the structure of the loan must be reasonable for the property type, borrower and lender. It is this combination of project, sponsor and lender whose interests must all be evaluated and equalized if one is to be associated with successful income-producing properties.
About the Author
For more information see East Coast Commercial Finance, affiliated with the National Association of Industrial and Office Properties, Urban Land Institute and Mortgage Bankers Association. East Coast Commercial Finance is located in Charlotte, N.C., and is involved in commercial real estate finance and investments.
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