How brokers can prepare a building for financing.

Every day, countless numbers of buildings fail to qualify for the maximum amount of financing needed to consummate deals at the best prices. In other cases, buildings fail to sell at all because the underwriters for mortgage companies were given contradictory and often misleading information.

There are a number of things owners and their brokers can do to avoid most of the problems.

First, accurate records of expenses and income must be maintained and must be verifiable. Records should not be in summary form, but contain all necessary details. While this is the responsibility of building owners and managers, the process can be guided and helped by their real estate brokers. The broker, if proactive, can certainly help to facilitate the consummation of deals.

When owners and managers fail to provide such information, the broker can step in and make sure that the proper materials are assembled and presented to the lender and underwriter.

Once accurate records are assembled, the building's owner, manager and broker should work in concert to make sure that all necessary remedies have been implemented. For example, one should proactively deal with deferred maintenance. If deferred maintenance is going to be more than 5% of income, it will significantly alter a deal.

Another important element is to remove certain corporate expenses from a property's operating expenses. For example, I've seen some landlords paying their family's medical insurance premiums from rental income. Although they may obtain a tax advantage, it could work to reduce the value of the property if they fail to keep accurate records, since net operating income will have been reduced. Believe it or not, some owners fail to explain and separate such non-property-related expenses unless you ask! Such extraneous expenses can have a negative impact on income and drive down the value of the property.

An even more common problem arises when the line between capital expenses and operating expenses has been erased. For example, a new air-conditioning unit or wiring for high-speed Internet connections are a capital expense, not an operating expense. Painting and carpet repairs, on the other hand, are operating expenses. The former should be broken out and itemized as operating expenses. If one places capital expenses into the operating expense category, one will reduce the loan value of the property. It is axiomatic that increased operating expenses will result in a decreased loan value, while capital expenses (i.e., investments in the quality of a property) will enhance a property's value and so create a higher loan value.

It's also important that income be broken down into the appropriate categories. I recall one instance (which I have simplified for example purposes), where the rent rolls we were provided showed apartment tenants paying $850 a month for rent on two bedroom, one bath units. This rental figure was substantially over market. Since lenders will underwrite to market rent as a maximum, one doesn't get credit in the NOI for any rents above market that a property may be obtaining; therefore, we were falling far short on the requested loan proceeds. Upon further investigation, we discovered that the building in question had garage/ storage units that other competitive properties didn't have. The garage/ storage units were rented to the tenants separately. The building owner had "simplified" his records by combining the unit rents with garage rents. This made all the difference: the full requested loan amount was easily provided. Mind you, this garage rental information was never offered by the building owner.

Ledgers were requested on the property and our underwriter was tipped off by some of the entries. This little detail could have made the difference in over a million dollars of loan proceeds; it easily could have been a deal breaker.

Concessionary leases pose another kind of problem: If a tenant has been given several months of rent-free occupancy, then that tenant's lease should be updated to show the real monthly rental income. Rent concessions discovered late in the loan process can be financing time-bombs.

With retail, office, or other commercial tenants, if between 20% and 40% of leases terminate within six to twelve months, then those leases should be extended, or one may find it impossible to find a lender willing to fund the deal. An alternative to extending leases might be a reserve held in escrow to cover the loss of rental income and anticipated rollover costs such as tenant improvements and leasing commissions. Some landlords, attempting to sell a building, will offer tenants whose leases are about to run out new lease extensions at below market rents. That will decrease the loan amount the building will support and will not work to the landlord's advantage.

Because a real estate broker should be aware of a lender's criteria for providing financing, the broker can guide the building owner and manager to eliminate red flags and rectify the kinds of obstacles noted thus far in this article. After all savvy brokers know exactly what kinds of buildings lenders are willing to finance and how much they are willing to finance.

Here are a number of commonplace negatives and remedies that owners, managers, and brokers should be aware of, for such problems if left untreated can often result in a deal not closing.

1. For a suburban office building, there should be sufficient parking spaces for all tenants. If not, then the landlord should make arrangements with nearby properties to use their parking spaces.

2. If restrooms are not sufficient to accommodate the number of tenants who will use them, then the restrooms should be enlarged or additional ones added.

3. If a building does not have high-speed Internet connections, it must arrange to be re-wired.

4. If a building does not have central air-conditioning, as many older office buildings do not, then the situation should be rectified.

5. One's building should compare well to nearby building or a cosmetic upgrade should be undertaken.

Real estate brokers should play a pivotal role in helping to close deals.

The broker should facilitate the entire due diligence process, and it begins with the purchase and sale contract.