Structuring Your Commercial Mortgages

Spring is taking two steps forward and 1½ steps backwards, but if you live in Vermont, that is close enough.

For the last couple of months I have been talking to our mortgage lender about refinancing one of our buildings. The building has been in service for +/- eight years and we expanded the building about 50% five years ago. Consequently we have 2 mortgages with one at 6.5% and another at 6.99%.

With interest at record lows it seems a good time to refinance. As I reviewed the term sheet there were a number of interesting clauses that we negotiated into our original mortgages.

The building was ideal rehab for our intended use and we had a tenant ready to occupy the space on a long-term lease when construction was finished. However, there were several things we didn’t do because of a slim budget. One was the roof. We were assured by three roofers that we would get at least 5 more years out of the roof. We came in with hard equity at approximately 23%. I then negotiated a $30,000.00 line of credit that went with the financing package.

Six months after the tenant took occupancy the roof started leaking to the point where the wall paper was peeling off the walls. We needed a new roof costing $50,000.00 and we had no money in the budget. I immediately called the bank for access to our line of credit. The roofer agreed to a cash payment of $30,000.00 and my development partner and I paid the balance off in 12 months with our cash flow from the building. Our equity partner received his uninterrupted monthly return.

The banker asked me if I wanted to keep the $30,000.00 line of credit with the new financing. The answer was, “Absolutely.” I now include a line of credit with every property I develop.

Our existing mortgages have terms of 12 and 15 years respectively and the bank wanted to give me a 15-year self-amortizing mortgage. I have always been a stickler on getting 20-year amortization with no calls but with 5-year rate adjustments and I rarely have a problem getting full-term financing.

In this case I countered with a 20-year amortization with a 15-year call. The reason is that this adds $1,500.00 per month to our cash flow and our principal reduction is slowed, thus reducing “phantom” income – income that is taxable but unavailable to you as in “mortgage.” The bank asked why I didn’t want 15 years and I told them and they understood.

When we negotiated the mortgage I asked one of the bankers why we had to personally guarantee all the debt. Why can’t we personally guarantee only that portion of the debt over 50% of the appraised value? He looked at the deal and said, “Hell, if the property is not worth 50% of its appraised value we aren’t financing it anyway.” I liked his logic a lot. In our refinancing term sheet it is still there: our 50% owner personally guarantees 10% of the debt and two 25% partners guarantee 5% each. Total personal guarantee is $150,000.00 of the $1,000,000.00 debt.

My last concern was the pre-payment penalty. The proposed pre-payment rate is 2% of the mortgage balance for 6 years. I will see if I can get 25% of the debt exempted in case I want to bring in a cash partner.

You need to envision the perfect mortgage terms and ask for it with the understanding that the banker’s focus is whether they are going to get their money back with interest. The banker knows that the more money you make the safer their investment becomes.

Good luck,

Steven G. Bushey, S.E.C.
(802) 343-3427

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