From Successful Single Family Fix and Flips (FnF) to Commercial: Bridge the Disconnect

I've been involved in investment real estate for a very long time and for the first time seeing multiple, successful fix and flippers (FnF) moving into larger commercial properties. I could not be happier for them! Real Estate entrepreneurs for sure.

Over the past year, my company, Silverthread Capital, financed FnF borrowers moving out of SFR into commercial properties and we're receiving calls every week with CRE loan inquiries. Because we're seeing some trends in their thinking, and some misunderstanding about commercial real estate lending -the 'disconnect'- I've written this short article hoping it can be of help to FnF entrepreneurs seeking financing on commercial properties.

1.      Many fix and flip (FnF) entrepreneurs are accustomed to using hard money lenders whose underwriting is largely dependent upon after renovation valuation models and an exit being the sale of the property. This model is relatively straightforward to put together. The arbitrage between the buy and the sell is a matter of known quantities: cost of rehab and the 'sold' comps or ARV, after renovation value. The lender can establish value fairly quickly and get comfortable.

2. Most SFR, FnF hard money lenders charge anywhere from 8 to 14% and, from 2 to 6 points. However, they are willing to close fast, be very flexible about the borrower's credit history and experience, and more than willing to take possession of the property should the borrower default. Also, on a smaller properties, the hard money lender can spread risk.

After doing multiple fix and flips, it's natural for a borrower to assume most bankers will look at lending opportunities similar to the way fix and flip lenders look at opportunities or at the very least, resemble the process.

So, looking at #1 and #2 above, let's compare those characteristics of a SFR fix and flip lender with a more traditional lender on a larger commercial or multi-family property.

First, bankers like to see the C's: good borrower CREDIT i.e. borrower has a history of meeting financial obligations on time; CAPACITY to repay i.e. property must throw off enough cash flow to cover debt service at a given, predetermined ratio or, if rehabbing the asset, borrower must have minimum liquidity and net worth requirements; good borrower CHARACTER i.e. bankruptcies and foreclosures need extensive explanations; good COLLATERAL i.e. bankers like to see properties that can be competitive in attracting good tenants. A banker also wants to see a borrower with experience with the asset class they intend to purchase. 

Second, because loans and liquidity seem to be abundant, most FnF borrowers believe they can achieve lowest rates at the highest leverage on stabilized properties. However, what a FnF borrower soon learns is if they have the liquidity and even the net worth, the best they may be able to do is 80% LTV on a new multi-family purchase with agency debt. Not bad. But, what the FnF borrower is unprepared for is the extensive underwriting and diligence that goes into getting approved for agency debt and the often unacceptable yield-maintenance penalties. Many growing entrepreneurs do not want equity to be locked up for as many as ten years.

Third, as mentioned above, one metric -ARV- is critically important to FnF borrowers and FnF lenders, whereas on a commercial or multi-family property a loan is sized based upon a DSCR; maximum LTV; a stress rate and differing amortization schedules depending on the asset class or property condition. In reality, and no matter what the bank's marketing flyers say, these metrics limit the Loan to Value to less than 75% -especially in today's low CAP environment- resulting in the FnF borrower needing more equity.

Fourth, a traditional lender does not want to own the property. A hard money lender is happy to lend money at high rates with the ability to gladly take possession of the asset should the borrower default. It's a business model. On the other hand, a bank simply wants to earn interest on the money they lend and, they want to be paid back. They do not want the hassle, headache or headline risk of taking back properties. It's not their business; they are not a partner nor are they predatory.

Contact me for more insights and information based on my years of making lots of mistakes and lessons I've learned. I'm happy to help, it comes naturally! Thank you!