Part III in a series: The Small Commercial Niche

"Success is dependent upon the glands -- sweat glands."
~Zig Ziglar

Welcome to the third article about specializing in market niches, becoming known as the expert in your market and getting rich. In our previous niche discussion, the focus was on reverse mortgages. This article will cover another specialized, yet highly profitable niche – “small commercial properties”.

While the rate of mortgage professionals delving into the commercial side of the business is rapidly rising, the percentage of experts in the field is relatively small. This side of the business is rarely taught and often takes 6+ months of on-the-job training/experience to get that first deal closed. In comparison to the residential side, a much smaller portion of deals close because there are more ways for the deals to fail. Not a pretty sight to see the broken-hearted broker who just spent 3 months on a deal, only to see it disappear like the wind.

Commonly, brokers who are asked by a borrower to help with a commercial deal (of any kind) do not know where to start. Nothing about commercial properties is taught in various state licensing exams and the niche masters themselves like this lucrative piece-of-the-pie just the way it is. Confusing, unrelenting and merciless. For the brave, there is wealth at the end of the rainbow.

The Only Thing to Fear...is Fear Itself

Perhaps it’s the mystery behind the commercial segment of the market that acts as a fog and prevents most brokers from taking that big step and venturing over to “the dark side”. One of the mysteries is related to the area of valuation. There are several valuation methods where commercial property is concerned, and to be honest, most loan originators have trouble doing simple calculations in their heads, like the ridiculously simplistic 139² or a laughably easy calculus equation such as:

For F = (x^2 + y'^2)^1/2, find;
partial dF/dx = x(x^2 + y'^2)^-1/2
partial dF/dy = 0
partial dF/dy' = y'(x^2 + y'^2)^-1/2
dF/dx = p.dF/dx + p.dF/dy.y' + p.dF/dy'.y''

All kidding aside, most people are not math experts and assume commercial property is all about the math. It’s really not. The money makers enjoy this stigma and will absolutely not do anything to disturb their monopoly. It’s really about marketing yourself and taking the time to “self-educate” in all aspects of the business, because short of having a mentor you can shadow day-in and day-out, that is the quickest way to success.

An important note - Don’t forget to think about the special needs of this niche borrower.

• What is their business like? Many small businesses/owners also own the land and building on which the business is run.
• Do they know how to tap their equity to expand/improve their business or to invest in another avenue of profitability? These can include auto repair shops, restaurants, light industrial, small apartment buildings...the list is almost endless.
• In sum, know what keeps your client up at night – a real pro will know what issues are burning in the client’s gut and will answer those questions before they are asked.

Another aspect that deters people from exploring commercial business is that the Federal government does not have the same rules and regulations in place for the lenders, brokers and investors. It truly is a new ball game, and the risk of learning something completely new bundled with the more frequent chance of failure deters the great percentage of potential commercial superstars out there.

Send Me in, Coach

We are going to concentrate on a small section of the commercial segment of the market, by far the easiest portion of this segment to grasp (for all those familiar with residential) is the small multi-family commercial apartment building (5 units and up). This segment can often mirror the residential 1-4 unit multi-family dwelling, but be careful not to confuse the two. While there are some similarities, there are several very big differences. From 5 units to 500, things get complicated in a hurry. However, it’s good practice to understand the common aspects of most transactions:

1. Appraisal
   1. Can start at $1500-$2500 and go much higher
   2. Paid UP FRONT to the appraiser at the door.
   3. There are no “drive-by appraisals” and there are no “realtor estimates” or comps.
2. Submission Checklist
   1. *see below for a “sample” commercial checklist
   2. Yes, some are not as detailed, but why not start at the top?
3. Retainer Fee
   1. As a professional, this will be an important part of determining the true nature of the borrower.
   2. Not all brokers/originators charge an upfront fee.
4. Know your Ratios
   1. LTVR: Loan-to-Value Ratio
      • LTVR = Total Loan Balances (1st mtg+2nd mtg+3rd mtg) / Fair Market Value (as determined by appraisal)
   2. DR: Debt Ratio
      • DR = Monthly Debt Obligations / Monthly Income
   3. DSCR: Debt Service Coverage Ratio
      • Formula for determining viability of property’s cash flow to cover the monthly debt service.
      • DSCR = Net Operating Income / Total Debt Service.
      • A ratio less than 1.0 indicates negative cash flow (debt service payments are higher than net income).
      • The most flexible approach to DSCR for a commercial property loan will require a DSCR in the range of 1.0 to 1.2, with exceptions permitting a DSCR less than 1.0. Since the area norm for the DSCR is often dependent upon your specific location, it can vary.

In addition to some of the more common aspects of the business, it is important to understand that there are varying loan amounts in this niche. Generally speaking, you’ll be looking at $100,000 for the very low end and $3,000,000 for the very high end of the small commercial market. Each expert has his or her own specific standards, which are usually tighter and more focused.

As you may have surmised, there are very many commercial properties in the $1million to $3million range. In fact, this segment in the commercial niche is much like the $150K to $300K in the residential market. It’s a prime segment with unlimited potential. If your ears are ringing, then you realize that one commercial deal at $3million can earn you as much or more than twenty-to-forty deals at $300K.

Do not be surprised to learn that fees of two to four points are the average for commercial deals, while the average residential commission is less than one point. That means that at the low end of a successful commercial deal, you might expect from $60,000 to $120,000 in fees on that $3million mortgage. If you’re earning less than one point for each $150K mortgage, it would take more than 40 deals just to equal the low-end commission of that single $3million mortgage deal.

Most residential mortgage brokers can hardly conceive earning that much on one deal, and almost all have some built-in morality compass telling them that they are not worth that much. You however, are different. You have not limited your goals and therefore your earnings. You, my friend, are open to the unlimited possibilities of success.

*Super-special hidden secret:
Many of the RESPA violations that residential mortgage brokers must avoid do not apply to commercial lending. This allows for many opportunities that are not available in residential lending. One major difference is the ability to pay for referrals. That is correct, you can pay people for referrals. There is no conflict of interest, no Federal law enforcement agencies to worry about, and best of all, a marketing avenue not available to residential mortgage brokers.

Poor People Have Big TV’s – Rich People Have Big Libraries

Ok, that was a brief introduction, but let’s face it, trying to cram too much information into your brain at one time is not an efficient way to learn. Grasping the general ideas lays the foundation for pursuing the more detailed aspects of the business. In fact, that brings me to the final segment of this article – business terms. You absolutely must become familiar with the vocabulary, vernacular, slang, “speak” and/or lingo of your specialty niche. Unfortunately for you, this niche has a larger than average glossary of terms. You will need to read and learn on a regular basis to stay at the top of your game. Examples of some common terms are as follows:

AAA Tenant

A tenant with a top credit rating. This type of tenant is often critical to the developer’s ability to arrange both construction and permanent financing for a major commercial project, such as a shopping center or office building.

ACREAGE

A 2 dimensional measure of land equaling 160 square rods, 10 square chains, 4,840 square yards, or 43,560 square feet.

BRIDGE/SHORT TERM LOAN

A short–term or interim loan for borrowers who need more time to find permanent financing or are repositioning a commercial property.

Base Rent

A set amount used as a minimum rent in a lease with provisions for increasing the rent over the term of the lease.

Capitalization

A method of determining value of real property by considering net operating income divided by a predetermined annual rate of return.

CONGREGATE CARE

A type of senior housing that typified by a central eating facility, smaller rooms, and a higher level of care for its tenants.

There are literally 1000 or more terms related to this market niche. With practice and experience, you really will become so immersed in the field that you are very comfortable using many of them.

There are many other subjects within this niche, including the various types of financing, how to put complex deals together, lease backs, cross-collateralization, hedge-fund equity lines of credit, co-brokering and much more. Don’t worry. You’ll learn those things as you gain experience in the business.

As is mentioned throughout history, that which is worth having is worth working hard for. In this business, your hard work and persistence will payoff with great success.

*Sample Submission Checklist

Deal Summary:
Include type of loan requested, loan amount, pricing, summary of operations, borrower’s name, principals and guarantor’s names, borrower credit history, purpose of financing, narrative history of property, location of property, physical description of property, collateral for loan, timing requirements, current debt on property/purchase price, cost of proposed rehabilitation or construction, sources and use of funds.

Borrower Information:
Complete description of borrowing entity including general partners, members and principals; current financial statements including description of real estate holdings, and resume.

Property Information
Complete physical description including; location with map, address, age, type of property, construction type, amenities, number of stories, unit breakdown, square footage (net and gross), number of units, number of parking spaces, date remodeled/list of capital expenditures, site plan, exterior/aerial photographs.

Operations:
Three years historic operating statements (if available), current rent roll including: tenant name, square foot leased, Rent per square foot, percentage rent clause and amount paid, pass throughs paid, first occupancy date, lease expiration date, and any renewal options. Include anchor/major tenant leases, detailed borrower pro-forma with description of changes from historic operations, current vacancy, historic vacancy, tenant improvements and leasing commissions paid or projected to be paid. Description of property management and relation to borrower.

Exit Strategy:
Proposed debt repayment, refinance via what sources and detailed explanation. Value upon completion. Market cap rate analysis. Monthly leasing and construction schedule.

Existing Financing:
Outstanding balance, description of any modifications made, lender, rate, monthly payment amount and maturity date.

Third Party Reports:
Include existing appraisal, environmental and engineering reports.

Market Information:
Current occupancy for sub-market and market, list of comparable properties, pictures, comparative details and map.

Please remember to be on the lookout for the next article in the Riches in Niches series: Bankruptcy Borrowers.

NOTE: This is the third in a short series of articles on the power of niches. Please watch for future articles. Click here to read the first article.and here for the second article

Grant C. Robin is a Nationally Recognized Mortgage Expert based in Miami, Florida. He is a niche specialist and has been mentored by some of the finest trainers in the industry. For more information about Grant C. Robin, contact his office at (786) 522-5321 or write to This e-mail address is being protected from spam bots, you need JavaScript enabled to view it