An Insider’s Look at Closing a Commercial Mortgage Loan
You’ve found the perfect building to add value and diversity to your commercial real estate (“CRE”) portfolio. You’ve lined up a lender to give you a commercial mortgage loan. How can you close your loan fast? Read on for an insider’s look at the closing process of a commercial mortgage loan.
What is a commercial mortgage loan?
Financing the purchase or construction of a commercial building (such as an apartment, office, or retail property) is ordinarily accomplished by obtaining a commercial real estate loan. A commercial real estate loan is a mortgage secured by a lien on the property itself. A financial institution such as a bank or insurance company will usually lend 65%-75% of the property’s value for a term of 5-25 years. Borrowers are customarily business entities, not individuals. Interest rates can vary. CRE properties typically generate income in the form of rents, which a lender evaluates when deciding the loan size and how much free cash flow (after operating expenses) will be available to repay principal and interest.
Hopefully – especially if this is your first commercial mortgage loan – you’ve already engaged a commercial mortgage broker to help you identify the ideal lender and loan for your transaction. A commercial mortgage broker will know the closing requirements of your lender and has probably already finalized multiple loans with them.
What documents will a lender require to close your commercial mortgage loan?
When requiring documentation for a commercial real estate loan, lenders focus on three main areas:
- The value of the property (or the “collateral”)
- The income or prospective income of the property
- The business entity’s creditworthiness and the real estate experience and its principals/owners (the “borrower”).
A complete commercial real estate loan package will provide detailed information to satisfy the lender’s due diligence requirements. The most commonly requested documents are listed below.
- A Recent Appraisal and Property Condition Assessment. The lender will order an appraisal, which should be no more than 60 days old at the time of closing. A commercial appraisal takes about three weeks and establishes the value of a property using three methods: the cost method, the sales comparison method, and the income capitalization approach.
A property condition assessment (“PCA”) investigates a building’s systems, improvements, and structure to determine if the owner needs to make significant repairs. A lender will use the appraisal and the PCA to confirm the condition of your property and verify the underwritten property’s value relative to the loan size.
- A Purchase and Sales Agreement. If you are purchasing a commercial real estate property, your lender will want a copy of the sales contract. The contract should not expire before closing. The sales price must match what you told the lender, or it could result in a cut-back of your loan proceeds.
- Income history. Unless the property is under construction, a lender will typically require you to submit a current rent roll and three years of “operating statements.” Operating statements will reveal gross income, occupancy levels, detailed operating expenses of the property, and net income.
- Leases. Your lender will review the terms of your tenant leases. Why do lenders review commercial leases? Lenders check leases to ensure no negative surprises to their expectations about the collateral’s rental stream. For example, your lender will want to analyze the rollover of lease terms to make sure the rental stream at the property doesn’t suddenly dry up in a few years due to multiple and simultaneous lease expirations. Does the current rent roll match up with the leases provided? Does the landlord/borrower have any sizeable financial obligations under the lease? Does the tenant have the right (known as “exclusive use”) to prevent the landlord from bringing another tenant in the same business into your center? These are just some of the questions a lender needs to answer. Lease terms impact the stability of the income of your property and the likelihood of loan repayment.
- Environmental report, title, survey, and proof of insurance. Lenders review these reports to ensure that in the event of a loan foreclosure, where the lender seizes the collateral to sell it, the property’s value holds up. The lender confirms that no hazardous materials or environmental cleanup are necessary and that the title and boundaries of the property are legally sound. Acceptable insurance policies must be in place to restore the property in the event of damage.
- Borrower’s Background. Creditworthiness is how a lender determines the likelihood that you will pay back their loan. In general, lenders will request two or three years of business tax returns, disclosing past bankruptcies or defaults, liens, and court actions to establish that a borrower is financially responsible. The lender will also check your business entity’s credit score (like a Dun & Bradstreet report) and the personal credit scores of the controlling partners. The underwriting process also includes assessing your years of experience owning and managing commercial real estate. The details of your current real estate portfolio, including loan balances owed to other lenders, will likely be requested.
How long does it take to close a commercial mortgage loan?
Closing a commercial mortgage loan usually takes an average of 30-45 days; however, many lenders can take longer. The better prepared you are, the quicker your loan can close. Your commercial broker will know which lenders can close loans quickly and efficiently. Commercial mortgage brokers also understand how to work with a lender’s closing team and save you time and effort to pull together the proper documents on time.
What are the typical commercial mortgage loan closing costs?
The typical closing costs for a commercial mortgage loan include the following:
- An appraisal
- Lender’s processing/underwriting fees
- Credit checks
- Environmental report
- Property Condition Report
- Title search/title insurance policy
- Mortgage registration
- Lender’s origination points (0%-2%)
- Commercial mortgage broker’s fee (0-2%)
- Legal fees
The costs vary by transaction. Legal fees tend to be the wild card. The lender’s lawyers will draft the loan documents, but your lawyer needs to review and negotiate any changes.
What are the common hurdles to a smooth loan closing?
Coordinating a loan closing that involves so many reports and third parties is not easy. Any delay in delivering the due diligence items to your lender will create problems and cost more money. Most lenders will hold their promised interest rate for the initial closing period, but if it extends beyond that date, your loan may be subject to an interest rate increase.
The most common causes of a delayed commercial loan closing include:
- A delay in receiving the appraisal or a low appraisal value that impacts the lender’s loan amount
- Title related issues that interfere with the lender’s secured interests
- Excessive legal negotiations
- Delays in getting tenants to complete lender required forms
- Syncing the loan closing with a payoff of your former lender, in the case of a refinance
Delays can be avoided by having the correct documents and reports delivered on time. It’s best to consult an experienced commercial real estate broker to ensure your loan closing stays on track.
Putting it all together.
Closing a commercial mortgage loan is complicated. It involves coordinating the delivery of third-party reports and extensive financial documentation. Any delay in providing the due diligence items to your lender will create problems and cost more money. The better prepared you are, the quicker your loan can close. Commercial mortgage brokers understand how to work with a lender’s closing team and save you time and effort to get your funds on time.