Why Commercial Real Estate Due Diligence is Important in Lending
In the lending world, commercial real estate due diligence is arguably an essential part of the job. However, it can also be a tedious, time-consuming process that can sometimes feel unnecessary. If you are a lender yourself, you know this can be the case.
To reinforce the importance of commercial real estate due diligence, in this article, we outline three areas where it can give you the information you need to be successful when making commercial loans, including:
- Understanding the property
- Understanding the borrower
- Repeatable lending criteria
Understanding the Property
Loan terms are critical when negotiating a commercial mortgage, but it’s the property itself on which you should focus. Since the property will act as the loan’s collateral, it pays to know as much about it as possible.
The due diligence period gives you the time and resources necessary to review the information you need about the property. Physical and financial characteristics are essential and will typically be provided to you or uncovered through your research.
Physical characteristics can include anything from the property’s current condition to its location, size, and needed renovations. The property’s current zoning is another piece of information you will likely want to know. This information helps give you an idea of what the property looks like today and serves as a starting point for the loan underwriting process. A thorough understanding of the building’s physical condition will make the rest of the process easier.
Financial characteristics include information like the property’s current and forecasted income and rent roll. This information will tell you whether the property is profitable and by how much. You will also likely want to request information on any plans the borrower has for improving the building, along with an estimated budget and timeframe. In addition, you will want to use the due diligence period to research comparable properties in the area to confirm that the requested loan amount is not more than what the property is likely to be worth.
These physical and financial information components are critical parts of making an educated lending decision and are all uncovered through due diligence. Without these data points, you wouldn’t even know what you were lending against.
Understanding the Borrower
Along with understanding the property that the loan will be going towards, understanding the borrower is an equally important part of the due diligence process. The property might be the collateral, but the borrower is the one who will be making payments on the loan.
Through the due diligence process, you will want to collect information on the borrower’s financial history, current financial status, and experience pursuing similar types of investments. A first-time investor undertaking a renovation project will have a different risk profile than a significant investment fund purchasing a profitable office building, so taking the time to dig into these details is necessary.
Avoiding a bad borrower at this stage is a lot easier than dealing with the headache of a foreclosure down the road. Even if the loan is non-recourse and the borrower’s other assets would not be available for seizure in the event of default, knowing that the borrower has plenty of cash to make payments will give you peace of mind.
Understanding the borrower is a vital aspect of a successful lending decision and is only possible by undertaking the due diligence process.
Repeatable Lending Criteria
Another often overlooked aspect of due diligence is that it can make your decision-making process repeatable. If you can identify which deals work, which deals don’t, and the crucial variables that caused the difference, you can establish lending criteria to apply to future deals.
For example, say you have gone through due diligence for several suburban office properties in recent months, but the deals never seem to work. Either the rent is too low, the vacancy is too high, or the borrowers don’t quite have the financial backing to satisfy your appetite for risk. However, at the same time, you have been able to successfully close deals for a handful of other office properties with the same characteristics, the difference being that they were located closer to a high-growth area in the city’s center.
In this case, going through the due diligence process on these properties has helped you narrow down your search and focus on only the deals that you know you can close on. While not every situation will be quite this obvious, repeatedly going through the due diligence process will allow you to understand what works and apply that knowledge towards crafting a repeatable, deal-closing funnel.
As you can see, due diligence is an essential part of commercial real estate financing that you should avoid overlooking. The information collected during due diligence gives you confidence in the property you are lending against and trust that the borrower will successfully fulfill their loan obligations.
Luckily, Finance Lobby makes the due diligence process more accessible than ever before.
Most complaints and headaches related to due diligence have to do with the time-consuming, outdated methods of gathering information like endless phone calls, emails, and documents. With Finance Lobby, all of the due diligence information is provided upfront in one easy-to-use interface, giving the lender access to all of the information they need from the very beginning.
Plus, you can specify their lending criteria only to see deals you are interested in pursuing, eliminating the frustration of analyzing deals that you won’t be able to close on later. This allows you to implement the knowledge you have gathered from previous due diligence periods and increase your close rate.
If you’d like to give Finance Lobby a try and see how it can streamline your due diligence process, create your free, personalized lending profile today. It takes less than 30 seconds to get started, and you’ll be analyzing your first perfect-fit deal in no time.