This is a transcript of an episode of the LeaseSmart Podcast.
Craig: I’m here today with Dave Repka of Bison Financial. As my listeners know, we talk all about facilities that business owners use and need and many times it’s leasing, many times it’s ownership. So I thought it was high time to invite Dave here to talk about when a business owner is purchasing a building or buying land to build a building. I needed Dave to give us some of his expertise on what to do, what not to do, and some of the things going on with the market today.
David: Thanks for having me here today Craig.
C: Great, glad to have you. I know from experience you do a lot of financing. What’s the biggest mistake you see people making today when they try to finance a building purchase.
D: I think it’s not starting early enough. There have been a lot of changes over the last few years. The landscape of lending and the local community bank that you thought would always be there for you maybe have been taken over by a large multinational company or they’re completely out of business.
So starting earlier in the process.
C: How early is early?
D: It’s never never early enough. I mean I think as soon as someone starts thinking about buying a property, they need to start coming up with a plan to get financing.
C: So even before putting a building under contract, they should have some discussions started with a lender that make them feel nice about lending them some money.
C: Also from experience, and you tell me if I’m wrong, I’ve experienced that some lenders don’t want to upset you so they tell you they’re interested and that they can probably do it. You think things are fine for awhile but at the very end of the day they say, “Sorry I can’t do that lone.” You should talk to multiple lenders to avoid this. Dave, what exactly figures into the borrowing formula?
D: Well, we work as a financial intermediary and a typical client will talk first to their relationship lender. Let’s say someone that they banked with for the last 5 or more years. Based on that response, they just don’t have that reassuring feeling that the bank understands the business and is going to advance capital for them to acquire a facility. So at that point, we’re brought in and rather than just having one source of capital, we’re able to go out to multiple sources of capital to find the best fit for that customer and for their business. The sources of capital would include banks, SPA, insurance companies, private lenders and credit unions. There are just a lot of different options. And unless someone is in the business on a daily basis doing this, they’re typically looking for only one, so that’s why we like to get involved at that point.
C: Okay so you would prefer that they have already talked to their own favorite lender and been rejected so now they appreciate what you’re doing for them and they’re happy to work with you.
D: It’s a more transparent event at that point because then there are no surprises. They already know that they’ve been turned down by XYZ lender. We’re free to go to the market place to find a source of capital.
C: How often does a borrower or potential borrower get turned down from his own lender and then you’re able to make that deal happen?
D: If they’ve been approved by their lender, they never contact us.
C: So you wouldn’t know the statistic then?
D: Correct! We’re only getting involved after they realize that time is ticking and they need to come up with a plan to find the capital to acquire the property.
C: Right, okay and when the time is ticking, you’re saying they may already have the building under contract?
D: Correct! They’re then going through the process of doing their due diligence and their certain deliverables that need to happen by certain days. For example within 30 days they need to do certain things according to their contract to acquire the property.
C: How often do you talk to people and you could confirm to them right upfront that they’re just not ready and no one is going to lend them any money on this building?
D: That happens on a daily basis and we’re really good and very efficient at telling people “No” and not giving “Maybes.” You can call it tough love Craig but you know it doesn’t do anybody any good for us to give somebody a “Maybe” on something that we know is not going to happen; so we tell people.
C: How do you get paid on these deals?
D: We get paid as a percentage of the loan amount at closing. We’re included on the closing statement and we’re paid directly from closing proceeds.
C: So you’re not getting paid money upfront to put together due diligence materials?
D: That is correct.
C: Wow! So I can see it’s in your interest to make sure that this is a financeable deal before you work on it.
So, the people who are not ready are not going to get funding. What’s their typical problem? Do they just have bad credit? Or not a big enough down payment? What kind of parameters do you see in the market today?
D: I would say it would be unrealistic expectations, that they believe that they’re going to get financed for something that is a stretch for them. Whether that is because they don’t have a big enough down payment, they don’t have enough experience, or there’s not enough cash flow in the business. There are a lot of reasons why somebody would get turned down.
C: Right. You’re lending both to investors of income property and to business owners that are operating their own business in the building?
D: That’s correct.
C: Alright. If you’re a business owner, then I’m assuming that you have to have a nice strong track record of the business cash flow and then after that it should be pretty easy. Right?
D: That’s the critical thing. It’s that the lender wants to see cash flow and consistency in their ability to generate that cash flow.
C: How long a term does the lender need to see?
D: The longer the better. I mean essentially a lender is going to ask for no less than 3 years of financials on the business as well as the owners of that business. Owners are defined as anyone that owns 20% or more of that business.
C: So if a partner owns 25% of the business, then the lender is going to need to dig deep into that person’s personal finances. Is that what you’re saying?
D: That is correct.
C: If one person has bad credit, that can kill the deal?
D: That could, absolutely. Or they could be over extended. They could have a lot of debt and contingent liabilities compared to their liquidity levels and net worth.
C: Okay, let’s talk about contingent liability for just a minute because I think a lot of people are not really familiar with that.
What would be some typical contingent liabilities that could be a real problem?
D: If they are a guarantor on a loan, that’s a contingent liability. If they borrowed money and signed personal recourse for that money, that’s a contingent liability. A lender is typically going to want to see what they call a Schedule of Real Estate Owned. In the Schedule of Real Estate Owned it’s going to give the address of a property. It’s going to give the borrower’s opinion of value and what the debt service is for that property. The free cash flow, etc. If they’re over leveraged and they have very little free cash flow, that’s something that is a red flag and it could cause a lender to turn down the transaction.
C: Right. That contingent liability may not be such a problem if there’s plenty of income to support that mortgage. Would that be true?
D: Yes. That’s correct. That’s why the Schedule of Real Estate will show what the income is for the property and what the expenses are for the property. What the net operating income is and the debt service breaking things down. To your point, we often see financial statements from borrowers that show things that maybe true and correct from an accounting perspective and from a tax reporting stand point where they include depreciation, amortization and interest but a lender is going to want to see those things as add backs to the borrower’s cash flow. We’ve seen that as a problem in why transactions have been turned down. It’s because of the financial statements. They’re providing financial statements or tax returns that are a different purpose that does not accurately show the picture of what the free cash flow is.
C: Right. At that point, it’s a good thing that they’re able to remove those deductions from their balance sheet. They’ll look better.
D: Sure. For example, looking at the PNLs, let’s say that the business has a million dollars a year in earnings. That looks very different than a business that’s at breakeven because it has interest cost buried in the expenses, amortization, and depreciation as well.
What a bank wants to see is an NOI number after reserve. Or an accounting speak an EBITDA number: earnings before interest taxes, depreciation, and amortization, and in certain property types if there are related party rents that are in there, that should be accounted for and broken out and foot noted as well.
C: Right, now I’m assuming another contingent liability will be if someone personally has a guaranteed a lease?
D: That’s correct. That is also a contingent liability.
C: Right, we deal with it all the time where the landlords want everyone to guarantee the lease and we talk about the contingent liability and I’m not sure how seriously it’s taken but you’re saying it can cause a person to not get financing, not be able to proceed with a business matter.
D: I was on the phone with a real estate developer for this morning who just found out that a tenant vacated the premises over the weekend. That tenant signed personal recourse on their lease and is going to be surprised to find that they’re named in multimillion dollar lawsuit because they had a personal recourse on their lease.
C: You bring up a couple of different issues that I have talked about in past sessions so we don’t need to talk about that now, but that’s an interesting perspective and point to make.
What are you seeing typically in the market as far as required down payments? Now I’m thinking of an average quarter-million dollar office space or half-million dollar retail store, of course it changes all the time, but what kind of terms, are typical in today’s market for a loan like that?
D: It really depends. If it is a small business that has the eligibility and ability to get financing thru the SPA and going to one of the SPA programs, if it’s in operating, existing business that is going, let’s say from rental space to space that they purchase, they can actually qualify for up to 90% financing and there’s some interesting nuances as well where if they need new furniture, fixtures and equipment, they need to do tenant improvements, that there are ways to actually increase the funding over 90%.
So there are some interesting nuances to that program. That can also happen in the case of let’s say start up hotel, where hotels can be financed with the SPA program for up to 80% of cost, because that qualifies as operating business.
Another type of property that’s recently been added to the program is self-storage facilities, where they can be financed as well with SPA.
C: That’s at about an 80% loan value?
D: Correct so we’ll call that the highest leverage point that would be available with community banks, relationship lenders, credit unions, etc., typically falling within the 50% – 70% loan-to-cost, loan-to-value, whichever is less.
C: Wow! I didn’t realize it was so low. That’s kind of tough for a lot of people. Okay, do you have any other great advice for our listeners about financing. Do you have any other typical problems we should know about or horror stories or great success stories or anything we should take away with us?
D: I think that a borrower needs to have a plan. They need to know what is going to be asked of them and what is going be required. It’s not a surprise that a lender is going to want to see 3 years of tax returns. They’re not going to want that in paper. They’re going to want that as a pdf file. The same goes for their personal tax returns and all of their corporate financials. So, the borrower who is able, on day one, to press send or better to have a dropbox or box.com folder set up where they have all of their data will be prepared. I think that is a very important and overlooked part of the process in getting ready to go out and borrow money.
C: Right. And, nothing is going to happen unless they have 3 years of records no matter where they go?
D: Correct.The only alternative to that is going to a hard money lender who is going to lend based on the collateral. So, if they’re buying a property for their business for 2 million dollars and they have a million dollars to put down, and they don’t have the greatest credit, an asset-based lender/hard money lender is going to be willing to look at that because their loan base is a million dollars out of two-million dollar asset is a good position to be in.
C: Right. So they’d practically be happy to take over that loan and resell it and maybe make some money then.
D: Correct. They’re not looking to do that as their primary business, but if they end it up with the real estate. It would not be the end of the world.
C: Right, it wouldn’t be too big of a deal. So now do you do lending all over the country? What area do you specialize in?
D: Correct. We work with borrowers all across the country that are looking to finance commercial real estate. Whether it is for their own business or investment properties ranging from office, retail, industrial, warehouse, apartments, mobile homes, parks, and self-storage, assisted living, senior housing, etc., the whole spectrum of income-producing properties as well.
C: What size deals do you do?
D: Closer to home, we can do smaller transactions. Nationwide, we’re doing transactions that are primarily 3 million and up for debt, and we also have access to equity capital, preferred equity and mezzanine capital as well for projects.
C: I don’t think I mentioned it earlier but your home is St Petersburg, Florida so you could do smaller deals in that region. What size is small?
D: It really depends on what it is. I would say that if it’s a purchase of real estate or an owner occupant, we could do transactions under a million dollars if they’re buying something for their own business, but there are very few sources of capital under a million. It opens up over a million. It opens up again over 3 million, and again it opens up even more over 10 million.
C: So that small business owner who really needs to borrow a quarter-million or half-million for his store or office, will have more difficulty and he or she really better have some good luck with their local relationship lender. Would that be true?
D: Correct. That is going to be best served through a local lender in the local market or through a lender that is going to be backstopped by an SPA guarantee.
C: That’s all very interesting. Have I forgotten anything that our audience needs to hear?
D: I think that one of the things to understand is if a borrower does have good credit, it’s a very good time to borrow. I met with a bank recently that, for the right properties, the right borrowers, will do interest rates in the 4s possibly even in the 3s fixed for a 5 year period of time. So, when you look at the historical spectrum, it is a fantastic time to borrow money.
C: Yeah, that sounds great. And they would still have to come up with 20% to 25% down on average?
D: Not less than that bracket.
C: Alright that’s interesting. So how can our listeners get in touch with you?
D: Our website is BisonFinancial.com and my email address is dave@BisonFinancial.com and my phone number is 727-537-0330.
C: Great! Well I hope you’re of great help to some of our listeners and I really appreciate your time.
D: It is my pleasure. Thanks for having me today Craig.