It seems that this would be obvious, but it is shocking how little attention the average investor devotes to profitability when shopping for a commercial loan. Learn the four most common mistakes and how to avoid them.
Malibu, CA -- (ReleaseWire) -- 12/04/2009 -- Unlike a home mortgage, the focus of a commercial mortgage is return on investment (ROI). When it comes to commercial real estate, the financing holds the key to making or breaking a deal.
The best commercial mortgage is the one that gets you the most ROI.
It seems that this would be obvious, but it is shocking how little attention the average investor devotes to profitability when shopping for a commercial mortgage. I see the same mistakes all too often, and they are the kind of mistakes that take a bite out of, or even destroy, the entire return on the investment.
Let's look at the four most common errors and how to steer clear of them when selecting a commercial mortgage in order to maximize return.
Mistake #1: Not having clear plans for the property.
It's hard to believe, but many people make decisions regarding investments simply because somebody said it was a good deal. More than a few people make financial decisions simply because somebody said it was a terrific opportunity. Some people get into property or investment without a game plan or any clear idea of their financial goals.
What's your vision? An annual return of 20%? For how long?
Are you looking for a property to renovate, rent to capacity and then sell?
By what date do you want to be in escrow, and at what price? Considering its location, is that a feasible plan?
Do you plan to locate your business there? How many years do you intend to live there?
Each of these matters needs to be addressed, as they all have the potential to impact the mortgage.
If you want to acquire a property and flip it, you'll want a different sort of loan with a shorter term than if you are looking for a long-term investment for your family.
HELPFUL HINT: Ask a commercial mortgage professional to review the deal before you take it to contract. When you're talking about your financial future, an ounce of prevention is, as they say, worth a pound of cure.
Just as you get professional guidance in tax and legal matters, always look to the pros when considering a commercial loan.
Don't rely on what your neighbor's allegedly wealthy uncle told him; get expert advice!
Mistake #2: Only considering the rate.
The lowest rate is not always the best deal with it comes to commercial property. Amortization is a huge consideration as well.
The term over which payments will be made is the amortization; longer amortizations, or a longer repayment term, result in lower payment amounts.
The lower payment renders better cash flow, more annual profit and a great ROI.
For example, a $500,000 loan with a 10-year balloon and a 15-year term at 5.5% equals a $4,085 payment each month.
The same loan amortized over a 25-year term at 6% would result in a monthly payment of $3221.
The same loan amount can have a rate of 1/2% higher, but a monthly payment that is nearly $800 less each month because of a longer amortization period.
If the investment nets you $1000 a month at 5.5%, the additional $800 every month on the longer term at 6% nets a return of more than 80%! And that is each and every month! FANTASTIC!
HELPFUL HINT: When reviewing approvals, run the numbers: use a calculator to figure out the exact payment on each approval.
Don't limit yourself to a consideration of the rate. Look at cash flow and profitability and see how they stack up with regard to your investment goals.
When you meet with the commercial mortgage professional, inquire about special programs the lender may offer. You may very well be surprised when you simply crunch the numbers and combine that with some good advice.
Mistake #3: Not shopping around enough early on, then shopping too much later.
Most people who want to refinance or purchase another property simply head to the bank where they do business. The do not comparison shop. Then the lender rejects their application.
Keep in mind that even if you are a sound borrower with a solid history, you may still be refused by your local bank for a commercial loan. You may wonder why.
The property may be, for one reason or another, a loser. They may have maxed out the month's funds allotted for commercial loans, or they may not be making loans on the particular type of property you're looking at. It's not personal; move on.
You will limit your options if you only apply to one bank without comparison shopping.
Continuing to shop after being approved at agreeable terms is nearly as bad as limiting yourself to just one lender. Be happy with getting what you were looking for and don't try to gild the lily.
This happens for a number of reasons. For example, if the rates increase, the deal will change. This could not only limit, but possibly eradicate, the profits. Don't take an approval to get a rate that's 1/8% lower and end up with one that's 1/2% higher!
As Wall Street knows: "Bulls and bears make money; pigs get slaughtered."
Also, the approving lender could change the terms. The institution may have set aside $30 million for apartment loans, but because of your inability to commit while you sought a lower rate, the lender committed its funds to other borrowers, and you're left empty-handed.
Again, keep your focus on the big picture and don't walk away from a long-term, profitable deal in order to lower your monthly payment $40. That's not wise financial management.
HELPFUL HINT: Take a step back and consider the big picture.
If you've run the numbers and feel that you can be profitable with the terms of the loan, book it and move forward. Don't let the entire deal slip away over your need to make an extra $10 a month! Think smart!
Mistake #4: Being so eager that you're not thinking clearly. The Bible points out that pride comes before a fall.
I've witnessed potential buyers pursue a property despite the fact that lender after lender rejects it.
If savvy industry people advise you to walk away, listen. Don't resort in desperation to private money at exorbitant rates that will never, ever turn a profit.
One of my wealthy friends says, "People would rather be right than rich," and I've seen that borne out time and time again.
Never forget that banks are successful when they lend money. They want to make loans that make financial sense.
If you hear from several sources that the deal doesn't sound good, LISTEN.
Extract yourself from the deal or take on a partner who has the chops to make it work.
Avoid feeling that you MUST have the property to the extent that you agree to unreasonable interest rates. Listen, weigh the advice and be wise.
HELPFUL HINT: In addition to having a conversation with a professional in advance of your purchase, double check your numbers to verify the deal remains viable. Keep your goals in mind at all times and remember what kind of return you want. Then consider the worst-case scenario. Are you able to deal with it?
Can you make an investment pay off if 14% is the best rate you can get on a loan?
Set your pride on the shelf and get up-close-and-personal with the numbers.
It's better to recognize a mistake, learn from it and be around to invest another day, rather than lose it all to save face.
By not making these four mistakes, your profits will skyrocket!