Loan philosophy: the difference between lenders and investors
As a mortgage broker, I am pleased to see a large number of potential loan transactions. I used the word “potential”, because not all of them work. Actually, there are quite a few turkeys with the swans!
A common scenario is a refinance or purchase where the investor comes to me with something like, “Man, this is the BEST property in the area, it’s worth $5 million, and I’m buying it for $3 million! I need a 90% loan and I need it NOW!” OK… so I’ve exaggerated a bit. In reality, the value of the property will probably be accurate to the market, but I will still receive a request for a loan with a high value.
Until recently, you probably couldn’t have gotten a 90% loan on a commercial property, except in the limited case of an acquisition loan guaranteed by the Small Business Administration. First, because no one offered a 90% loan on commercial property and second, because the property probably wouldn’t have supported debt service.
The big change in that scenario has been the advent of the “small balance business lender” in recent years. They combine commercial and residential underwriting methods to get higher LTVs. I’ll save an article on this type of lender for later because I want to focus on why a conventional commercial lender really doesn’t care how big of a deal an investor is getting on a particular property. It is because there is a very basic difference in philosophy between the lender and the investor.
An investor is concerned with maximizing the return on his capital. Whether it’s through leverage, adding value by making improvements, or adding value by improving a property’s cash flow, the goal is to make as much money as possible on your capital investment. The return you receive is proportional to the risk you take on with your capital investment.
A lender is concerned with something completely different: getting the money back! A lender also views a loan as an “investment.” In fact, in the lending business we often call our lenders “investors.” But these investors approach their investment from the point of view of managing their risk in exchange for an acceptable rate of return: the interest rate of the loan. The property that the investor sees as a growth asset, the conventional lender sees only as collateral for the loan. (Again, I’m not talking about private lenders who might have other motivations.)
So when you hear an investor say something like, “I don’t understand why they didn’t give me the loan! The property is worth a LOT and they can always get it back if I don’t pay!” Well, the reality is that the lender doesn’t want the property back…he just wants his money back, as agreed.