Commercial Real Estate Finance The Deal Book
By Mark DeLoof, Vice-President - Commercial Real Estate
I have an opportunity to invest in a piece of income-producing commercial real estate, but I only have a limited amount of my own capital to put into the investment. I'm going to need financing assistance. What do I need to provide my banker with in order to obtain the balance of the capital to complete my investment?
This is a familiar refrain. As bankers, we meet with commercial real estate developers and investors who have a wealth of information; however, it tends to be all "upstairs." One of the keys to getting the deal done is providing your banker with a comprehensive package of information commonly known as the Deal Book.
Ah, the Deal Book. It's nice to see everything in a neatly organized album, but at the end of the day, as is said all too often the guts of the deal book is what really matters. What is going to persuade your banker to provide you with the majority of the capital that will be needed for your investment?
First and foremost, both you and your banker need to understand the project. Start simple. There's always a story about every deal. How about a picture of the project and surrounding properties? A location map would be helpful in telling your story. A survey and site plan would also be helpful. How did you get this opportunity? What are terms of the purchase? What's the name of the ownership entity? When was it formed? Who are the partners? What are the backgrounds, qualifications, and roles of the partners? What is the ownership breakdown of your entity? Why does this investment make sense for your partners and you? Paint the picture for your banker.
Beyond the story-which is always a good place to begin-make certain to include three key components: (1) a total cost budget or a breakdown of the sources and uses of the total investment; (2) detailed project cash flows; and (3) detailed personal financial information.
A total cost budget is a must. Show the sources and uses of the total investment and ensure all costs of the investment, including soft costs such as interest carry, property taxes, leasing or sales commissions, appraisal fees, survey costs, title insurance premium, environmental testing, and closing costs, are identified.
Demonstrate your understanding of the costs per square foot or unit. Are these aggressive, realistic, or conservative? How do these compare with other like projects? Note: don't forget to include an amount for contingencies to cover cost overruns, as Murphy's Law comes into play in almost all commercial real estate investments.
The heart and soul of the deal is the cash flow. Cash flow from the project is the primary source for repaying your bank loan and is also the foundation for the value of the property. The value of most income-producing commercial real estate investments is equal to the net present value of the cash flow generated from the investment, so be prepared to use a discounted present value of the projected income stream to value your property.
There is no substitute for historical cash flow information. Whether it's an existing project or a new one that you plan to develop, the reliability and dependability of cash flows is key to helping your banker feel comfortable with your ability to repay the loan. Show all of your key assumptions (e.g., lease terms, tenant information, square footages, rental rates per unit or square foot, a vacancy and credit loss estimate, management fees, detailed operating expenses, debt service assumptions, etc.)
Finally, be prepared to provide your banker with detailed personal financial statements and several years of federal income tax returns of all the partners. A key point to make here pertains to the level of detail provided on personal financial statements. Back in the good ol' days (prior to 1985), banks relied upon personal financial statements that were almost exclusively a balance sheet or net worth statement. Err on the side of disclosure; provide any and all items pertaining to your investment and financial condition. If disclosure becomes a game of hide and seek, the chances of getting your loan approved will greatly diminish.
Today, an adequately prepared financial statement provides details on all assets and liabilities with particular attention paid to liquid assets that should be supported by bank and/or broker statements. It also includes a cash flow statement that details all sources of income, debt payments, living expenses, and contingent liabilities. For borrowers with multiple projects, this means providing information on the cash flow of each project in which he/she is an owner.
The above components represent the guts of your Deal Book and will be a great way to get your initial meeting off to a good start with your banker. While not mandatory in your initial presentation, other items your banker will likely want to see before final approval include information about the general contractor, architect, civil engineer, contract documents, legal description, easements, municipal approvals, zoning, permits, project timeline, construction schedule, environmental conditions, soils conditions, leases, leasing agent, lease-up projections, marketing plan, and property management.
