Thoughtful Financing

Before we begin, let me wish you a Happy New Year. Blessings to you and your family. With that said, let’s talk about some aspects of financing.

I made my first loan in August 1972 while working for a finance company. It was an unsecured note loan for $300. (Average monthly income at that time was just $926 a month.) I was careful because if you loaned the money and the person didn’t pay you had to collect it back. It was a great training ground and over the next 3 years I made a lot of loans that were unsecured and others that were secured by cars, furniture, and sometimes even freezers full of food!

What I learned about the most was risk. There’s risk everywhere and the key is mitigating that risk as much as possible and still make money. So we learned if delinquencies were too high we were not off setting risk and if delinquencies and losses were not high enough we were passing up business.

Times have changed but one thing has not; lenders don’t like risk. Let me repeat that, lenders don’t like risk. They like profits however, so putting a package together that will pass muster and attract attention needs to address the lender’s worst fears. Lenders don’t want delinquencies, they don’t want losses, they don’t want to have nonperforming assets on their balance sheet, they don’t want regulators or auditors making a visit, and they don’t want to miss out on a promotion. And your loan needs to address all of those fears plain and simple. If you don’t have that in your mind all the time it’s going to be more difficult than it needs to be.

Recently a pretty sophisticated commercial property buyer visited a large commercial property here in Salem and eventually purchased it. He wasn’t flying solo, he brought a team to be his experts, his eyes and ears and to give him advice. He had a Dream Team. In addition to himself, he had his attorney, property manager, and the Real Estate Broker. Each of these people can tell him something about the property that he might not know or see from a unique perspective. They might ask questions he might or might not ask. And the property manager was looking at the property from an operational standpoint.

Any lender is going to be very interested in knowing you have a Dream Team and that you have opinions from each to support what you intend to accomplish. In fact, the roles played during the purchase and after in the case of the property manager, should be featured in your proposal and business plan. If there is any concern about income and debt repayment you can offer to have the property management company pay debts to include the mortgage and property taxes. One way to reduce risk and make the lender more comfortable.

One of the solutions or options that lenders have become dependent upon to reduce risk in their minds is the personal guarantee. And just about all attorneys seem to want to add that language into a lending agreement unless they represent the borrower. I’m pleased it makes the lenders feel good but it’s a false glow in my opinion. The lenders seem to think it puts more pressure on the borrower but if a business or loan is going bad more pressure usually only leads to desperate decisions and subterfuge. Plus, a borrower’s family, children’s college fund, or furniture didn’t borrow money. So to wipe someone out is poor form and a weak attempt to make a bad loan look good. So, I’ve learned to never sign personal guarantees. I learned the hard way. If someone or an institution insists I go somewhere else. I have always found someone who doesn’t need my signature in blood. But I do keep the risk low!

With risk there is a layering affect too. It adds up to the point no one item pushes the project over the edge, it is the accumulation of many risk factors. So that the Loan to Value Ratio might be ok but not a lot of room for market movement. The rental income is good but it relies on current tenants and you’re at 95% occupancy and not all tenants are on long term leases. Parking is close but the city has a tendency to suck up parking like leaves in the fall. The roof looks good but it is in the last 5 years of its expected life. You don’t have an anchor tenant. The numbers work but there is no room for a bad quarter. Too many layers of risk even though the numbers work right now. Something has to improve. LTV has to get better with a larger down payment, or an anchor tenant is needed with a long term lease with CPI built in. Something needs to improve.

Some years ago my partners and I were working on a big project that had good numbers, good appeal in the market and was ahead of its time in many ways. We were moving forward at a reasonable pace and working with some good lenders who liked the project. Interest rates were good and fit into our business plan so we felt we were good to go. What we ran into however, was a loss of appetite! The market for these type of loans was full and obviously so was the secondary or investor market. So it’s good to know what investors are looking for in the long run, what you’re competing with like in the stock market or the bond market, and what mortgages are doing. Talking to your banker, and better more than one, will take you a long way. And better yet is doing some of your own research. The meal you’re serving may look good but if they aren’t hungry it doesn’t matter.

This paragraph started out the first time with an essay on putting together a second business plan that had a hit in income reflective of another pandemic for the Lenders. But really any more everyone should have it for themselves. Even if you currently own a property and have been unaffected by the pandemic at this point it would be good idea to have one ready. During my time with the Army we were always exercising plans that hopefully would never be needed or see the light of day but it was good to know they were there. And we were looking for holes in the plans or looking for areas that needed updating. The world is constantly changing and plans need to be updated to reflect our changing environment. The same is true of a business plan.

From a lender’s perspective, it’s good to know you have that back-up plan, that you’re ready, and that your debts will be covered. Again, it’s about the risk and not becoming an item to be dealt with by the lender or their boss.

So I think you get the point and then some. Think like the lender… risk, exposure, keep it easy and keep it simple. Create your own Dream Team and make that arrangement work for you. If you don’t know the value of a good property manager and or don’t have one now, give us a call. We’ll fill you in.

Tom Cowan, Jr. is a private investor, a long-time Salem resident and lifelong Oregonian. He is retired from the ODVA after a 27-plus year career culminating as the Deputy Director and COO. Tom’s also a retired Captain in the Oregon Army National Guard. He has also jointly owned and operated several businesses in the healthcare, real estate and education sectors with great success. Reach him at: TOM@PIKESNW.COM