Did someone say Shopping Center?
For real estate investors looking to expand their commercial portfolio, shopping centers can be a profitable investment. Here’s what you need to know when approaching a lender.
With the apparent collapse of the subprime mortgage market and its effect on the economy as a whole, real estate investors may be looking for a commercial alternative to the residential market. Shopping centers can be a great place to start, especially well-established and completely occupied shopping centers.
High-end malls, which are typically anchored by a national retailer or department store, are likely out of the reach of most individual investors. But smaller shopping centers, those with less than four stores that can be valued at around $200,000, are a worthwhile investment option when compared with single-tenant properties, because the economic risk is generally spread over multiple tenants.
An investor exploring the shopping center market will need to do his or her homework. First, it’s smart to learn how shopping center investments are financed. After all, if you can’t work out the financing, it’s time to move on to other options.
Owner occupancy
If the investor who is going to occupy and operate a business within the shopping center, the property may be viewed as owner-occupied. From a financing perspective, this is the most favorable situation.
The percentage of owner-occupied square footage is important. Some lenders want to see 50 percent owner occupation, while others will accept less. The most common requirements range from 20 percent to 40 percent.
If a borrower doesn’t meet the lender’s percentage guidelines or doesn’t occupy any of the square footage, the property is considered an investment property. Interest rates are higher and loan-to-value (LTV) ratios are lower for investment properties.
Down payments
The minimum down payment required on all shopping center loans is 10 percent of its value. If you do not have the 10 percent, you’ll need to find it before applying for a loan with just about any lender.
Credit score requirements
When applying for a conventional loan, the minimum middle credit score allowed is 600. However, some lenders have minimum standards that begin at 620 or higher. The standards for investment properties are usually higher, and lenders may require a middle score of 640, 660, or 680 and higher. There are exceptions, and the parameters vary by lender.
Types of mortgages
There are three primary types of mortgages — full documentation, stated income, and low documentation. The interest rates will be lowest with full-doc loans and highest with low-doc loans. LTVs will be highest with full-doc loans and lowest with low-doc loans. It is generally in the borrower’s best interest to qualify for a full-doc loan, as the long-term savings benefits far outweigh the short-term benefits of less paperwork. A global income loan type also exists for cases where the property income is not high enough to support the debt. With this rare loan, the borrower’s personal income can be added into the qualification calculations.
In cases where the seller’s tax returns are not strong enough for a purchase loan or the borrower’s tax returns are not strong enough for a refinance loan, a stated income loan may be the answer. This type of loan requires no tax returns or any type of income verification. Generally, the maximum loan amount is $1 million and the LTV limit is 75 percent. But subordinate financing is allowed up to 90 percent combined loan-to-value. Usually, loan amounts more than $600,000 may require additional documentation.
Subordinate owner-financing
The maximum LTV for the purchase of an owner-occupied property is 90 percent. Usually, the borrower will need a minimum credit score of 620 and must qualify for a full documentation loan. In most cases the maximum LTV for an investment property is 80 percent. Many lenders allow subordinate owner-financing up to 90 percent LTV. So if a borrower only has a 10 percent down payment for the investment property, the seller will need to hold at least a 10 percent second mortgage.
Loan sizes, amortizations, closing costs, and prepayment penalties
Lenders have different minimum and maximum loan amounts. For most, the minimum loan amount is $100,000, while the maximum loan amount usually depends on the lender’s limit, the borrower’s credit score, documentation type, and whether the property is classified as investment or owner-occupied.
Amortization terms typically are in five-year increments. The most common amortizations range from 15 to 30 years with various fixed-rate and adjustable-rate options.
Closing costs for a commercial loan are affected by many variables, including the lender, size of the loan, type of loan, LTV, borrower’s credit score, supply and demand, and local market forces. The investor is usually responsible for all closing costs. With some negotiating, however, the seller may pay some or all of the costs. If the investor’s down payment funds are limited, the seller may have to pay the closing costs if he wants to sell his property.
Many commercial loans have a prepayment penalty if the loan is paid in full prior to a certain date. This penalty may be for as short as one year or as long as 10 years.
Debt service coverage ratios (DSCR)
It’s important to understand the concept of debt service coverage rations when dealing with commercial loans. However, borrowers typically have to estimate the DSCR, because they might not know the final interest rate on their mortgages. Ultimately, the lenders calculate the DSCR, because they know what the interest rate will be on the loan. However, you can come up with a rough idea.
The DSCR is the ratio of the monthly net operating income (NOI) to the monthly mortgage payment. The concept is simple, and it reveals the amount of cushion a borrower has between the monthly mortgage payment and the monthly net operating income.
To illustrate, if a borrower has a monthly NOI of $100, it wouldn’t make sense to sign off on a loan with a monthly mortgage payment of $150. With every payment, the borrower would be another $50 in the hole. But if the numbers were reversed — monthly NOI is $150 and the mortgage payment is $100 — the borrower would have a $50 cushion in case the NOI decreases.
To calculate the DSCR using this example, you simply divide the monthly NOI of $150 by the monthly mortgage payment of $100 to reveal a DSCR of 1.5. For shopping centers, lenders will want to see the property cash flows using a 1.20 to 1.35 DSCR, depending on occupancy, credit, vacancy, and maintenance reserves.
Research is key to investing in shopping centers
With a wide variety of financing options, shopping centers are excellent income-producing properties. Plus, the money can be easy to get.
Investors need to conduct thorough research, however, to determine the value of each particular shopping center, as well as how to assess their value before plunging into this investment area.
