Real estate investments start at lending source

Commercial banks, life insurance companies and commercial mortgage-backed security pools, commonly known as conduits, all provide commercial and multifamily real estate loans. But how does each vary? As a borrower, it’s important to know which lending source is best for a particular piece of property, weighing the pluses and the minuses of each before making a decision.

One of the first questions to answer is whether the project represents a short-term investment or need. Short-term is considered one to five years and long-term is seven to 10 years or longer.

The three lending sources generally fall into two categories: banks, which are generally the preferred source for shorter-term loans, and conduits and life insurance companies, which are the better choice for longer-term needs.

A review of the funding behind each source sheds light on why one works better than another for a specific project.

• Banks are generally lending against short-term deposits – checking accounts, money-market accounts and certificates of deposits. This makes it somewhat difficult for banks to make longer-term loans at a fixed rate of interest.

• Life insurance companies, on the other hand, have liabilities that are of a longer-term nature, such as annuities and life insurance policies. They are taking in premium dollars today and looking for ways to invest them with the intention of paying benefits out at a future date.

• Conduits are a relatively new lending source, only coming on the scene in the mid-1990s. Conduit loans are originated, then pooled with numerous other loans into a bond-like security. Investors are then offered the opportunity to buy pieces of the security called “tranches.” These tranches are rated by rating agencies such as Moody’s based on their relative risk level and are traded on Wall Street, just like corporate- or government-issued bonds. These loans are almost always for a 10-year term, at a fixed rate of interest.

Bank programs

Due in large part to their desire to keep their loans on a shorter duration, commercial banks’ lending programs are generally best suited for the acquisition of properties still in the early stages of development and leasing, and for the construction of new properties. Their programs tend to be short-term in nature with interest rates that float over an index and allow the borrower to repay them in full at any time during the term. If a property is being acquired and will be repositioned in the market, a commercial bank is the logical choice until the property is stabilized and cash flow is at a higher level.

Life insurance

Life insurance companies have historically been the primary provider of longer-term, fixed-interest-rate loans for more stable properties. Loan terms generally carry fixed rates of interest for 10, 15, 20 or 25 years and provide loan amortization of 25 to 30 years. Historically, life companies have held the loans that they originate on their own books. While life companies lack the ability to offer the flexible terms that a bank can provide, this does allow them some flexibility to make modifications to the loan after it has been closed. Life company loans are a logical choice for properties that are stabilized, or very nearly so, and where the borrower intends to keep the property as an investment for the foreseeable future.

Conduits

Although conduits have been in existence for a short period, they have become a dominant source of funding for commercial real estate loans. They have separated themselves from commercial banks and life insurance companies by maximizing loan proceeds and generally providing the lowest cost of capital.

Conduits are primarily focused on cash flow from the property, although master leases from borrower/sponsors have been used to bridge temporary vacancies in the property. Conduits require uniformity in loan documentation, along with reserve requirements for taxes, insurance, building components, leasing commissions and tenant improvements.

Loan terms are generally for a fixed interest rate for a 10-year term with amortization periods up to 30 years. Interest-only periods of between three years and 10 years have been structured into conduit loans in the past several years. Of all the loan sources, conduits are the least flexible when modifying terms after they have been closed and placed into the securitization pools.

The answer to which funding source is best for a particular real estate investment depends on many factors. It pays to consult an expert in the field before proceeding, as the right financing can make a huge difference in terms of the ultimate value of the property.

Phil Bird is a vice president of Q10 Triad Capital Advisors in Kansas City. Q10 Triad Capital Advisors is a full-service mortgage banking firm that serves commercial and multifamily clients throughout the Midwest. Bird may be reached at www.q10triad.com.