Explore the basics of applying for and obtaining a loan, from interest rates and points to the letter of intent and title insurance. Get started on your loan journey.
In This Article:
- The Loan Application and Approval Process
- Discrepancies in Commercial Property Lease Agreements
- Presenting Accurate Property Numbers to the Bank: How to Avoid Mistakes
- Improving Your First Impression: Marketing the Numbers for the Super’s Apartment Rent
The Loan Application and Approval Process
The following is a basic outline of the loan application process:
- The borrower submits a request to the lender for financing.
- The lender provides a verbal quote that includes the main points of the loan – amount, term, and rate.
- The borrower may request the lender to lock the interest rate. This means that the lender commits that the rate quoted will be the final rate when the deal is closed. Most banks charge a refundable fee for locking a rate, and the borrower is given a limited time in which to close. It is therefore only common to lock a rate within 30 days of the projected closing date.
- If the quote is acceptable, the bank will reduce the quote to writing and provide a document called a letter of intent (LOI). The letter of intent (together with the term sheet) sets out more details and conditions of the loan, including projected closing costs (fees incurred by the borrower for transferring ownership).
- A bank will not close without title insurance.
- The lender’s and broker’s fee is charged in the form of a percent of the loan and referred to as “points”. The standard fee is one point. On a $2,500,00 loan, the fee would be $25,000.
- Do not confuse the percentage of the fee with the rate of the loan. When a borrower takes a loan at 7%, and is charged a 1% bank fee, it is a loan that must pay 7% interest annually, in addition to a one-time fee of one point. It is not a rate of 8%. [These fees are referred to as ‘points’ and not ‘percents’, so as not to confuse the two.]
Discrepancies in Commercial Property Lease Agreements
When preparing loan packages on commercial properties to be presented to the bank, it is extremely important to read through each individual lease on the property. Many times you will find discrepancies regarding details of the lease between the lease agreement and the information that had been provided to you by the landlord. Often, these discrepancies go unnoticed even by the landlord.
An area where such discrepancies are common is in the details of the tenant’s reimbursements. Following are two examples of such discrepancies:
You may be told by the landlord that a tenant, occupying 10% of the property, reimburses all expenses above his base year on a pro-rata basis. Thus, if total base year expenses were $1,000,000, and year two’s expenses were $1,200,000, the tenant would be responsible for reimbursements of $20,000 (10% of $200,000). Upon careful reading of the lease, however, you may discover an entirely different story.
It is common that a lease will stipulate a cap on reimbursements. Thus, the lease may state, for example, that the tenant is responsible to pay a pro-rata share of all expenses above the base year, up until 5% above the prior year’s expenses. In the above illustration, by the second year, the expenses rose 20% ($200,000). The tenant, however, is only responsible for a pro-rata (10%) of up to 5%, above the previous year’s expenses, which comes to only $5,000 (10% of 5% of $1,000,000). This is a difference in the tenant’s responsibility of $15,000!
It is true that should such a mistake remain unnoticed the landlord would gain considerably. It would add $15,000 to his income, thus raising the value of his property and enabling him to obtain a bigger loan. Nevertheless, to submit the loan as is would be unethical and a clear misrepresentation of the lease. In addition, during the bank’s underwriting process, the error will be caught and the bank will credit the overestimated amount back to the tenant and deduct it from the landlord’s income. Your clients will appreciate and respect you more when such issues are dealt with upfront rather than allowing them to go unnoticed which can hurt them later on.
Base Year Discrepancies
Another example of base year discrepancies: A lease is signed with a tenant, with the year 2004 serving as the base year for tax reimbursement. In 2004 the landlord paid $1,000,000 in taxes. Upon reviewing the taxes, the municipality concluded that the taxes were overpaid by $200,000 and in the year 2005, refunded the landlord the difference. Thus, the actual taxes paid for the year 2004 is only $800,000.
In the year 2005, the taxes amounted to $1,000,000. The landlord now demands from the tenant his share of the $200,000 raise in taxes since the actual taxes for the base year was only $800,000. The tenant will claim that since at the time the lease was signed the taxes paid were $1,000,000, taxes have not exceeded the base year, and the tenant should not be responsible for any reimbursement at all. This sort of discrepancy is common in cases where taxes are prepaid based on a prior year estimate, as it is in many municipalities, or when they are paid months after the period date for which the taxes were prepared.
This situation is usually resolved by referring to the lease. In most cases, the lease clearly states that the reimbursements are calculated based on the actual base year expenses, not the amount that the tenant had assumed based on the original payment.
Presenting Accurate Property Numbers to the Bank: How to Avoid Mistakes
A mortgage broker may never change numbers when presenting the setup of a property to the bank. However, it is important to know how to present the numbers in a way that accurately reflects the facts and also makes a good first impression on the bank.
As you have seen, the bank underwrites vacancies for all properties. The number used for the vacancy is usually the average vacancy rate for the area of the property. This number is applied to the net rents of the property. It is therefore important to assign rent for every available space, even those that are presently vacant. If you do not do this you will be allowing for vacancy twice.
For example: In an apartment building in an area with 5% vacancy that has a gross potential income of $800,000, the vacancy will be assigned as $40,000. If there is an actual vacancy of 5% and the gross rent was entered as $760,000, the vacancy would be applied onto that amount, leaving the bank with a total income of $722,000 ($760,000— 5% of $760,000 [$38,000]). Thus, the vacancy is, in effect, being taken off twice. However, if rent is assigned to every space, then the gross income would be $800,000, and the vacancy of $40,000 would reflect the actual vacancy.
This is no small difference. In the above example, if the property is being assessed at ten times profit, the amount of value of the property lost on such a mistake amounts to $380,000!
Improving Your First Impression: Marketing the Numbers for the Super’s Apartment Rent
A common example of marketing the numbers for the best first impression is the rent assigned for the super’s apartment. Often, the salary of the super is that he receives his apartment rent-free. In these cases, the landlord may fill in a zero in the space for the rent of that apartment on the income and expense statement. In the expenses section, instead of writing an amount for the super’s salary, he will write “free apartment”.
Without changing the bottom line at all, these numbers can be presented in a much more appealing way to the bank. For the rent of the super’s apartment, enter the amount of rent that such an apartment is worth. In the ‘expenses’ column, deduct that amount as the super’s salary. Either way, the same thing is happening; the super is getting free rent for his services. But presented in this way, the numbers have a better effect. One of the first items a lender looks at when assessing the numbers of a multifamily property is the gross rent amount. Based on this amount, a lender will decide if the loan amount being sought is at all commensurate with the value of the building. In our case, because we applied the super’s rent, the gross rent was increased by $12,000 a year. If the building is being valued at six times gross rent, this setup yields an added $72,000 to the value of the building.
1. What is a letter of intent in the loan application process?
A letter of intent (LOI) is a written document that sets out the details and conditions of the loan, including projected closing costs and other important terms of the loan. It is provided by the lender after the borrower has submitted a request for financing, and if the quote provided by the lender is acceptable to the borrower.
2. Why is it important to review commercial property lease agreements before presenting them to the bank?
It is important to review commercial property lease agreements before presenting them to the bank because there can be discrepancies between the details of the lease agreement and the information provided by the landlord. These discrepancies can have significant financial implications for the landlord and the tenant, and it is important to ensure that the lease agreement is accurately represented in the loan package presented to the bank.
3. What are “points” in the loan application process?
“Points” are fees charged by the lender and mortgage broker as a percentage of the loan. The standard fee is one point, which is 1% of the loan amount. It is important to note that these fees are not the same as the interest rate on the loan and should not be confused with it. The borrower must pay the interest rate annually in addition to the one-time fee of one point. At GPARENCY, members can use our full commercial mortgage broker services for either $11K max paid upfront, or ¼ point paid at closing.
4. How can mortgage brokers avoid mistakes when presenting property numbers to the bank?
Mortgage brokers can avoid mistakes when presenting property numbers to the bank by ensuring that they present the numbers accurately and clearly. It is important to double-check all calculations and to be honest and transparent with the bank about any issues or discrepancies. Mortgage brokers should also make sure to include all relevant information about the property, including any potential challenges or risks.