How NOT to Waste Your Money on a Commerical Property Transaction

I wish I had a dollar for ever prospective purchase who called me, excited about a prospective purchase of a piece of commercial real estate.  They call to pick my brain for a “free appraisal” of what their property is worth, especially first-time marina buyers.  So I launch into my pitch that my time is worth money and they ask for a fee quote.  I give it to them, gladly.

Sometime later, I find out that they really didn’t want to pay an appraisal fee that was not much higher than a residential appraisal.  I understand commercial appraisal fees are expensive, yet what I find truly, truly sad is that they don’t know how much money they are wasting on a deal that won’t close… and if it does close, doesn’t make financial sense.

Today I’d like to give all commercial property purchasers out there THE answer.  It will save you thousands and most cases, tens or hundreds of thousands of dollars.  But to do so, we have to think about how cash flows out of your pocket and into that of the lender.

Loan Costs 101

Here’s what you need to know about the costs of that loan you’re about to get.

One of the biggest hurdles we face when assisting borrowers for a commercial loan is not finding the money, it is getting them to pay a “processing fee” or “due diligence fee” to the lender after receipt of the Letter of Intent to Fund (LOI).

Virtually every lender we have worked with over the last 16 years charges a processing fee.  This fee ranges from $2,500 to $10,000.  The fee is used by the lender to order third party reports — appraisal, environmental review, survey, etc., as well as to cover other due diligence costs.

We realize the fee seems steep and, relative to residential loans, it is.  It has been our experience, however, working with many private funds for both conventional and hard money commercial loans the average fee ranges between $5,000 and $10,000, depending on the type of loan (hard money or conventional) and the type of property being funded.

Some lenders we are aware of regularly charge even higher due diligence fees of $15,000, $25,000, $50,000, or an up front fee of 1% to 2% of the loan amount being requested.  That means for a $3 million loan a 1% processing fee would require the applicant to pay $30,000 before due diligence is completed and in most cases the fee is non-refundable.  (Note: we don’t work with these types of lenders, such fees are excessive and in too many cases the lenders don’t perform, leaving the loan applicant high and dry).

That up-front fee is a killer!  It costs more than all other loan costs combined!  Ah, but we’re not done there.  There is another type of expense that every lender will require before it comes time for an appraisal:  the Phase 1 Environmental Site Assessment.

The current rate for a professionally done standard Phase 1 inspection is approx. $1800.00 – $2000.00.

Now, what happens if the Phase 1 recommends further testing (i.e. a Phase 2)?  Say “ouch” because that’s the sound your pocket book makes when it hears what those cost.  This is not as far-fetched as it seems; plenty of properties have the “potential” to have some contamination from a nearby property.  I’m not saying it’s probable, but if it does occur, you can add thousands of more dollars on top of that for a Phase 2.  And add lots more time to the due diligence period.

So now you’ve waited for a while for the Phase 1 and paid a hefty processing fee.  Time’s up… I hope you’ve got an interest rate lock.  If not, your loan rate will go up in step with the interest rate during the due diligence period.

And all this time, you still don’t know if your deal is going to work.

The Wild Card That Must Be Played

You’re out some pretty hefty bucks with no guarantee of closing the loan and buying that property.  The last step in the process is the most risky for you.  It’s time to get an appraisal.

Maybe the appraisal says you’ve hit the nail on the head and bought the property at the right price.  The operative word is maybe.  You’ve spent thousands if not tens of thousands of dollars on a maybe.  You wouldn’t spend this much on a hope of a stock going up or down.  You wouldn’t spend this at the casino’s craps table.  Why spend it on the hope you’ll get the property to “appraise?”

Changing the House Rules

Would you like to know how to virtually guarantee you’ll get to the closing table?  Are you ready for the punchline?  Get the property appraised before you spend all this money, time and effort.  You’ll know if the property is really worth the amount you’re about to buy it for and with a good appraisal in your hand, you should be able to close the loan much faster considering that you’d have to wait 30 to 60 days to get a valuation from a commercial appraiser anyway.  More importantly, if the property is not worth what you’ve contracted to pay, a good appraisal will give you the leverage to save at least tens of thousands of dollars, and more likely hundreds of thousands of dollars.  If the owner won’t negotiate, you know the lender won’t loan on it on the terms you want since it won’t “appraise”, so it’s time to shop for the next deal.

There are plenty of hungry sellers willing to negotiate a lower price if you prove to them they’re asking too much.  You’re in the driver’s seat.  It’s a 100 percent buyer’s market.  Take advantage of it!  You’re only out an appraisal fee rather than a hefty loan processing fee, a Phase 1 fee, a survey and other costs… but you’ve removed the biggest obstacle to closing the deal!

It’s strange how people follow the same outdated set of rules.  Sign the contract of sale, complete the loan documents, write the check, let the lender order the Phase 1, write the check, then get an appraisal and write the check.  Start with the end in the beginning… or you might be starting at the beginning all over again.

John Simpson, MAI