Real Estate Finance

Peter B. Rotch
Director, Real Estate Department
October 1, 2004

The recent combination of low interest rates and increased fervor with which commercial banks are pursuing real estate-based loans has created an opportunity for many small to medium sized businesses to consider purchasing their property for the first time.

Owner occupied transactions are forecast to be an appropriate business strategy for the foreseeable future, but just how does a business owner go about purchasing his or her building? Like most business transactions, the keys to success are understanding the other person’s priorities, and preparing a pitch that addresses those priorities. The business owner who can provide the lender at the initial meeting with detailed information about the company, the property, and future prospects increases the likelihood of a positive response and a commitment to provide the necessary financing.

In this case, the business owner of a small to medium sized business looking at a purchase price of $1,000,000 to $10,000,000 will generally be talking with a commercial banker. The lender is interested in two primary considerations, (1) the ability of the business to repay the loan and (2) the value of the property which will be security for the repayment of the loan.

What to bring to the table

The business owner should be prepared to address a number of key issues including the basic loan request, the business history and prospects and financial performance of the company, the background and financial capacity of the principals of the business, the real estate to be acquired and the legal structure of the real estate ownership entity.

Prior to meeting with the lender, the business owner needs to consider the amount of the loan being requested. In a real estate acquisition loan, a commercial bank will generally loan between sixty percent (60%) and seventy-five percent (75%) of the appraised value of the real estate. There are several loan programs sponsored by the US Small Business Administration which, if the business and the transaction meet their criteria, will enable the bank to increase the loan up to ninety percent (90%) of the value of the real estate.

The lender will be interested in the history of the business, how long it has been in existence, the number of employees, the current management and management structure, the ownership and ownership structure, the company’s products and services and the company’s niche in the market place, and the financial performance in the past three or more years. This is the business owner’s opportunity to “sell” the lender on the value of the company and the acquisition of a new business property. The lender must have confidence in the business and its prospects, or it will never seriously consider a loan to purchase the business property.

Since the bank will lend only a percentage of the value of the property, the principals of the business must have a plan for providing the balance of the purchase price or the equity in the project. The principals must also decide whether they will become personally obligated for the loan. In most cases, this will be a requirement of the lender. A variety of funding sources can be used to meet the equity requirements including accumulated cash in the business, personal funds from the principals, outside investors or some form of seller financing. However, junior financing may not be attractive to the lender if regular amortization is anticipated because of the adverse effect on the cash flow of the business.

The business owner should review with his accountant and attorney how title to the property will be taken. Will the property be held in the name of the operating company or will the property be owned by principals of the operating company (a common situation) and then leased to the operating company? Currently the entity of choice for real estate ownership is a limited liability company, (“LLC”), but each situation is different and has pros and cons and different ownership entities need to be discussed with professional advisors.

Assuming the lender likes the prospects for the company, the business owner must now “sell” the property he or she wishes to purchase. Prior to meeting with the lender, it is highly advisable to pull together the following information relating to the real estate project:

  1. Location
  2. Ownership
  3. Condition
  4. Appraisal
  5. Environmental history

By the time the business owner meets with a lender he or she will probably have a Purchase and Sale Agreement with the current owner which will contain all of the conditions of the purchase. A copy of this Agreement should be given to the lender. If he or she is meeting with the lender prior to obtaining a commitment to purchase, he or she will need to provide the lender with a binding agreement to purchase before any action will be taken on approving a loan.

Location, location, location

Location is important in all real estate transactions, and commercial owner occupied properties are no exception. The presentation to the lender should include (a) maps showing the relationship of the site to the municipal center, the road system, other transportation facilities, (b) a tax map, and (c) if available, a detailed plan or survey showing the legal access, number of parking spaces, loading docks and other features which make the property suitable for your needs. Actual surveys recorded in the Registry of Deeds or in possession of the owner are helpful and provide information of the layout of the property and its relationship to surrounding properties. Such surveys will also be helpful in determining whether or not additional survey work will be required by the lender. If new construction is contemplated, the business owner should anticipate that a full survey of the lot will be required as well as an “As Built” survey as a condition of construction. The maps and surveys should be supplemented by information relating to the current zoning of the property and any other land use requirements which will impact the ability of the business to operate on the property. For example in some communities, a change of use will require the submission of a new site plan. A strong presentation should give the lender a good picture of the site and its suitability as a location for the business.

Any information relating to the condition of the facility, including parking lots and driveways, will be helpful to the lender. Although the business owner may not have inspection reports at the initial meeting, photographs provide helpful information.

The business owner will not have a current appraisal at the initial meeting, but obtaining tax assessments and information from the broker regarding sales of property in the area are advised. The appraisal, which must be ordered by the bank, will be a significant document in determining the value of the property and consequently the amount of the loan.

Although environmental reports will probably not be available at the initial meeting, a summary of the past uses of the property will allow the lender to evaluate the environmental risk from contamination by hazardous wastes. Underground fuel storage tanks are always a concern, so any information regarding underground tanks should be obtained.

Relocating a business to an owner-occupied property is an existing prospect which can provide advantages to the business and the business owner. An organized presentation to the lender will get the project off to a good start.