What does it take for loan officers and mortgage brokers to feel comfortable with a potential acquisition or refinancing deal? At the top of their response list is undoubtedly the location of the asset and the cash flow from the operation, immediately followed by the strength of the person or entity sponsoring the deal.
The strengths of a deal sponsor — the individual or entity ultimately on the hook for repayment of the loan — is of paramount importance to a lender. For example, is the borrower creditworthy? Does the borrower have property management experience? The answer to those questions can often spell the difference between obtaining favorable financing terms and terms that make the transaction burdensome, or near impossible to accomplish.
Partnerships are powerful
To begin with, debt and equity providers look at a potential borrower's experience with the particular asset type in need of financing. This may seem like a trivial matter, but it's critical. For example, a borrrower seeking a high-leverage multifamily acquisition and rehabilitation loan on a 25-unit apartment building in a Cleveland submarket will need some experience with residential properties, rehabilitation projects, and an overall familiarity with the Cleveland submarket.
But what happens to this deal if the borrower only has extensive experience in, say, the northwestern Pennsylvania market and with mostly retail strip malls? Does this eliminate the prospect of favorable financing terms? A diligent loan officer would likely advise the borrower of ways to strengthen the deal, capture the business, and provide favorable financing terms.
One of the options available to the borrower, in this instance, is to partner with a contractor and or project manager with extensive multifamily renovation and repositioning experience in the market where the asset is located. If the borrower insists that the renovation project be managed by a long-time friend or relative who is an office construction specialist in, say, the south Florida market, that will not help obtain favorable financing terms. Borrowers should be aware that lenders demand a higher return on loans for assuming additional risk, such as weak deal sponsorship.
Many mortgage brokers and direct loan officers encounter frustration when working to convince a potential borrower that the best option for obtaining favorable financing terms lies in partnerships. These business arrangements can include bringing in project management and contractor partners who can strengthen the outcome of a financing bid.
Risk mitigation
It becomes important to lenders — particularly in cases of high-leverage loans — that borrowers are amenable to lining up project partners who have a proven track record in the same property sector as the asset under consideration for financing. Those partners must also have the appropriate licenses and experience to ensure that the sponsor receives the lowest interest rate and most favorable terms possible.
This relatively simplistic piece of advice is worthy of consideration by the savviest of real estate investors, particularly when it comes to other aspects of a deal such as the hiring of a leasing agent or building manager. While it may be a bit of a blow to an investor's ego to seek operating partners that mitigate risk in a potential deal, the rewards are far greater than going into a financing transaction with weak sponsorship.
Lenders do take note when deals from a particular borrower or entity regularly pop up in the marketplace with weak sponsorship. Despite the flood of capital in the real estate finance and investment space today, prudent and risk-averse lenders do turn down some deals, and it's often due to weak deal sponsorship.
And if an investor develops a track record of presenting lenders with deals that consistently have weak sponsorship fundamentals, favorable financing terms will always elude that investor, driving him or her into the hard-money and non-conforming sectors. There, lenders will demand repayment terms and interest rates at a high premium, which can directly impact the real estate's financial performance.
Finally, adding strength to one's deal sponsorship may also include hiring internal personnel or naming business partners who bring a broader scope of experience to the table. Real estate investing is a business operation, and successful developers, investors and building owners are rarely lone rangers. Instead, they are forward-thinking planners who understand and take advantage of other people's professional strengths.
W. Joseph Caton is managing director of Oxford, Conn.-based Hartford One Group, a real estate finance consultant.