Why Lenders Change Terms Mid-Transaction

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What to do when it happens and how to avoid an unnecessary retrade.

by RUSHI SHAH

In the world of non-traditional and non-community bank financing, it’s all about balance. Because the capital is market-based, a lender’s term sheet will reflect the combination of interest rate, loan proceeds, term and reserves that is necessary to ensure the property’s cash flow will cover the debt payments for the life of the loan. If something upsets this equilibrium mid-transaction, the lender may need to adjust the terms to recalibrate the loan’s profitability and credit risk profile. There’s no free lunch. If the information changes during the due diligence from the time the deal started, terms might also have to change to reflect the changes.

Often these imbalances are out of a borrower’s control or only become apparent during the normal due diligence process. Other times they are a case of a lender or intermediary overpromising and underdelivering. Regardless of the cause, there are actions you can take upfront to minimize the risk of negative mid-transaction changes and leverage the benefits of any positive changes, in order to close with the best possible loan structure.

DON’T OVER-SHOP YOUR DEAL

A common borrower misconception is that the more lenders that look at your deal the better your results. This strategy, however, usually backfires and sets you up for a potential retrade. When the market gets frothy and multiple intermediaries are over-shopping a deal to too many lenders, disreputable brokers or lenders may purposefully offer up below market terms as bait to win the deal. Then once you are too far down the path to switch directions, they’ll retrade the loan terms, usually to the borrower’s detriment. Bottom line, if it sounds too good to be true, expect to be retraded.

CHOOSE AN EXPERIENCED AND COMMITTED INTERMEDIARY

The quality of the person you trust with your financing at the beginning will affect the quality of the financing you secure in the end. Your intermediary should pre-underwrite and professionally package your loan request, and be transparent with you about the risk of any changes to your deal story. Intermediaries should have a lot of leverage in the process due to their experience, relationship and expertise with the lenders.

Look for an intermediary who is actively closing deals in your market or for your property type at borrower-favorable terms. This is evidence that he or she has the lender influence, creativity and market knowledge necessary to accurately size your deal upfront, as well as creatively restructure around any issues that show up later, to get you to the closing table.

For example, in one situation the borrower expected a 10-year franchise agreement, but as we neared closing the franchise advised it was only willing to offer a five-year commitment. This could have killed the deal. We cured the pain point by offering higher FF&E reserves temporarily to the lender as insurance against a potential future flag non-renewal. If the borrower gets hit with a future significant PIP, he can tap into the reserves without jeopardizing his ability to make his loan payments. If no PIP, the reserves get released upon extension of the franchise agreement. This gives the borrower peace of mind.

In another situation, the borrower was able to get clear title on all but one of the borrower’s portfolio of hotels. Instead of allowing one property to hold the entire deal hostage, we were able to hold back the troublesome asset to close later once title was cleared.

PRIORITIZE WHAT MATTERS MOST TO YOU

Even when bad news makes a restructuring unavoidable, your intermediary can make it more palatable. Sharing what is most important to you as a borrower, such as term, rate, or proceeds, will help an intermediary push and pull the right available levers to structure for your goals.

For example, we had a deal where midway through the due diligence process a second subordinate mortgage on the property became a roadblock for the lender. Anxious for the long-term interest savings of the new loan, the borrower agreed to pay off the subordinate loan prior to closing, if the lender increased proceeds to allow for cash out. The borrower was able to pay off the higher 7 percent interest rate loan and refinance to a 5 percent interest rate loan.

LEVERAGE POSITIVE CHANGES TO IMPROVE YOUR TERMS

Sometimes variables change in the borrower’s favor, creating an opportunity for your intermediary to negotiate with the lender to sweeten the terms. We have had several instances where we started with loan amount X and closed at X + Y because the appraisal came in higher than expected or cash flow increased in favor of the borrower. For example, the borrower for a recent bridge loan expected $12 million and closed at $12.5 million.

WATCH FOR RED FLAGS

To avoid an unnecessary retrade, prepare for a possible restructuring and close at the best rates and terms available for your property, choose who you work with wisely and keep an eye out for the following red flags.

  • The terms are too good to be true and don’t align with the market.
  • The numbers don’t add up. If the term sheet says the property is at a 12-debt yield and when you look at your cash flow and apply the formula the metrics don’t work, you should hit pause.
  • The intermediary doesn’t have the deal flow. In this business, volume equals influence with lenders.
  • The lender doesn’t have decision-making power or control over approval of the loan. For example, the lender has a warehouse line of credit with another capital source who could derail the loan late in the game.
  • The intermediary or lender doesn’t understand finance or how to structure a loan.               ■

Rushi Shah is CEO of Conlon Capital, a commercial mortgage banking firm formed by a merger with Aries Capital, which specializes in CMBS and other non-recourse lending solutions. Over the past 26 years, the Conlon and Aries teams have collectively funded more than $8B for hotel, multifamily and other commercial properties. Shah held previous positions at Northern Trust and is a member of AAHOA’s Founding & Allied Member Committee. Shah holds an MBA from The University of Chicago’s Booth School of Business.

Photo credit: ©iStock/wutwhanfoto

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