Lenders Weigh in on Investment Sales

Recently one of my clients, looking to sell an office condo, inquired:
"I'm wondering what rental income a prospective buyer would like to have for an office space based on comparable properties, and desirable Cap rates, which would then drive a buyer's offering price?"

In light of my client's question and last week's investment sale profile, I thought it would be useful to follow-up with a look at the viability of commercial investment sales in this economic climate. Since almost no deal is done without financing, I turned to some local lenders I have worked with and trust for insight and answers.

My questions to them and their responses below:
What sort of Cap rate is your bank looking for on an investment purchase and what sort of down payment for an investor these days? Also what lease term, as in years, would the bank require?

Andrew Fuller, VP, Virginia Commerce Bank:
Generally, for investors we're looking for 25-30% down with lease terms of at least 5-7 years with options. Leases should be seasoned for have some measure of financial depth or, we'll look to personal guarantees. A lot of banks are cutting back on investor deals these days altogether along with construction and other parts of the market like hospitality. In regards to Cap rates on investor properties, we don't have a maximum and don't generally use that when screening deals. I was told the CoStar report shows an average of about 7.5% for investor buildings/projects under 50K square feet.

Paul Flood, VP, M&T Bank:
Cap rates, that's a tough one... it is always an art rather then a science, but right now I would put it the high 7's, low 8's range for general use commercial property. As I'm sure you know money for commercial real estate investment is very tight right now. For me to get deal done, the borrower has to has to have sizable existing relationship with us or potential for it. Non-owner occupied commercial real estate loans are a defensive product for us, but if the situation is right we will do it to win a relationship. Down payment: I would normally tell you 25% and possibly stretch it to only 20% for a particularly strong deal, but in today's environment, you're looking at 30%.

Jeffrey Lee, VP, Access National Bank:
In general, we would look for a 75% loan-to-value, and a 1.25X debt service coverage. The lease term should be coterminous with the loan; in other words, if you are looking for a 5-year loan, the lease should be at least 5 years. The numbers vary based on the strength of the deal.

Andrew Brkic, VP, Bank of America:
Our options for investment property are few and far between at the moment. We're looking for a loan-to-value maximum of 65% and a Cap rate of 8-9% for non-0wner occupied real estate. In terms of lease requirement: 2 years or more. However, if a property has consistent historical lease income, i.e., 10 years with consistent rents, we will consider properties with a shorter lease. In terms of commercial space, owner-occupied is really our sweet spot and we can do those in-house at 80% loan-to-value, or 90% loan-to-value through the SBA 504 program.

To address my client's questions:
Overall none of the lenders have absolute parameters, just guidelines. A shorter lease can be acceptable with a tenant who's been in a property for many years and has financial depth and operating history. Exceptions can be made for an investor who puts down more than 25%, for example, so the debt service coverage is good, or for an investor who has good credit, outside income and solid financial position.

The National Association of Realtors®reports that the office market is feeling the impact of the recession, a result of high unemployment shrinking demand for office space. On the brighter side, the Washington DC metro market ranks 8th in the nation for lowest office vacancy rates due to one of the lowest levels of unemployment nationwide. Investment money appears to be out there for financially strong buyers and mortgage rates for commercial real estate loans are at historical lows.

Both these links, Cash Flow Analyzer and Advantage Software provide useful information on investment terminology. I include them not to promote the software products they are selling, which I've never used, but because they provide good explanations of Cap rates and other investment terms.