What Do Lenders Really Want from Property Managers?
By Michael Giese, Executive Director, Glenstar
There are times when it seems that lenders, loans and reporting requirements are a mystery, and that one misstep could potentially put your funding in jeopardy. With so much at risk, how are property managers supposed to know what lenders want?
Minimizing Risk Through Key Metrics
To get some perspective, let’s take things from the lender’s point-of-view. They are often providing debt for the purchase of an asset, as well as potentially proving future funding on construction improvements and leasing commissions.
As lenders have already committed to funding your project, they attempt to minimize risk as they seek a return of their investment. With this, there are generally four key things to keep in mind:
- Income and expenses
- Major leases
- Ongoing construction work
- Tenants delinquencies
Evaluating these areas helps the lender continually evaluate whether the building is likely able to meet its loan obligations.
Increasing Lender Requirements
Lender requirements have increased over the years. Today, for example, many lenders use consultants to review and confirm construction completion percentages.
For example, if a lender provides $10 million of future funding for building improvements, lenders may have independent consultants review the project, verify completion percentages and evaluate construction documents.
This makes it critical for property managers to read loan documents and understand reporting requirements, including which documents need to be provided and when.
Additional Notification Requirements
In addition to reporting construction progress, what other notifications do managers need to make? Tenant defaults are usually one. If you have a tenant and they are not paying, the manager must typically report that to the lender.
Additionally, there may be cases where expenses are greater than or revenues less than the lender approved budget. Loan documents generally provide reporting thresholds on variances that need to be reported. Variances that do not need to be reported on are generally referred to as permitted expense deviations.
When Alarm Bells Go Off
When revenue falls short or expense overages occur, it is important to follow the reporting requirements outlined in the loan document. You do not want to do anything that places you in default of your loan covenants. Full transparency is important.
If revenue begins to fall short or expenses climb too high, the lender may reduce future funding.
Let us say the lender was going to provide $10 million of construction funding, but because the largest tenant is not paying, the lender could lower that amount to minimize risk and maintain the debt service coverage ratio. The debt service coverage ratio (DCR) is a number based on the net operating income over the debt service. Once your ratio drops below an acceptable level, defined in your loan document, the lender typically has the right to move (sweep) your revenues into an account they control.
For example, a building takes in $1 million in rent this month. Usually, that $1 million would flow right into an operating account to pay for goods and services. However, if your DCR is poor, the lender may hold the $1 million, pay themselves the debt service and hold money for taxes and insurance, before sending you the rest.
Understanding the Budgeting Process
From an annual perspective, managers are generally required to give lenders a budget on a specific due date, with the lender having somewhere between 30 to 60 days to approve. While you will not want to start spending on larger projects without an approved budget, urgent issues involving emergency repairs could arise. In any event, typically any expense variance that exceeds the loan parameters generally require written approval from the lender.
Over time, lenders have requested review and approval of certain leases and material service contracts, so your team should know which types require a lender approval. Let’s take a closer look at some of these:
- Many loans require lender approval for service contracts that exceed a certain term, even with a 30-day cancellation.
- Service agreements that do not have a 30-day cancellation policy sometimes require lender approval.
- Occasionally, service contracts with annual payments exceeding a certain dollar amount, such as $1 million, may require lender approval.
- If proposed leases or amendment do not meet pre-established minimum guidelines, they often require lender approval.
You should communicate with your lender regularly and with full transparency.
At the end of the day, what lenders want is a return of their principal and interest. How much are we pulling from the loan for commissions and capital redevelopment? What is the monthly debt service? What is the building’s cash flow, both today and future? All of these are important questions.
As you become more knowledgeable about what lenders want, you will find that regular and transparent communication benefits multiple parties, including lenders, services, owners and managers.
From improving lender relationships to understanding accounting principles, BOMA/Chicago offers over 20 education programs for property management teams just like yours – and you can take them virtually too. Learn which program is the right fit for you by visiting our Education section or contacting Jaclynne Madden, Director of Education, at firstname.lastname@example.org or 312.870.9608.