Lender Perceptions

When evaluating a potential loan recipient, lenders examine a number of aspects of the potential borrower and of the property itself. Lenders have criteria that must be met in a number of important areas. These areas can be considered the five “Cs” of credit:

• Character: What is the character of the borrowing individual or firm? Has the borrower ever defaulted on a loan payment or does he or she have an unblemished borrowing history? Has the borrower hired a Certified Property Manager (CPM) or an Accredited Management Organization (AMO) to manage the property?
• Capacity: Does the property have the capacity to produce an income stream? What does the cash flow sheet look like?
• Conditions: What are the loan terms?
• Collateral: How will the loan be supported? What is the value of the property? What is the ability to pay expenses and capital improvements?
• Capital: How much does the borrower have at risk? How much additional capital does the borrower have available to fund unexpected shortfalls or meet other capital needs?

Lenders consider two basic factors when pricing loans — risk and yield.

One measure of risk is the amount of loan as compared to a property’s market value, which is generally established by a property appraisal. By law, most institutions are limited to lending only a certain percentage of that value. Another measure of risk is the magnitude and reliability of the property’s income stream. Specifically, the risk is in how well the income stream covers the interest and principal payments on a loan. For new projects, another measure of risk is the developer’s financial strength. A portion of this risk is the developer’s proven ability to successfully complete proposed projects.

Yield is a function of the annual interest rate and the term of a loan. The interest rate depends on the current state of the money market and the internal costs of institutional funds. The term of the loan depends on the borrower and lender. Longer-term loans require a higher yield than shorter-term loans. Both interest rates and the term of the loan influence the risk associated with a loan. The greater the risk, the greater the required yield.