Rich Dad Education – Real Estate Blog

Dedicated to Elevating the Financial Well-Being of People from All Walks of Life

Real Estate Loan Due Diligence

The greatest mistake you can make in life is to be continually fearing you will make one.”  Elbert Hubbard

We all face fear on a regular basis and most overcome the fear with experience and knowledge.  As a Real Estate Speaker it scares me how some new investors will spend days and months analyzing every aspect of Due Diligence on a property and then blindly sign loan documents without even reading, let alone understanding, the terms.  So to help alleviate both our fears I am going to discuss loan due diligence this week.

Unlike most residential loans the commercial loans are not “Set it and forget it” documents.  During the term of the loan you as the borrower will have ongoing responsibilities in order to stay in compliance.

Let’s begin with shopping for the loan.  Everyone understands comparing interest rates but in many cases a few other terms may be more important.

  1. What is the term of the loan?  While most loans are amortized over 25 or 30 years in many cases commercial loans will need to be modified in 3, 5, 7 or 10 years.  If interest rates are low and you plan on holding the property for more than five years you may chose to pay a slightly higher interest rate to gain a longer term loan and avoid paying modification costs and possibly much higher interest rates when you modify the loan in a few years.
  2. Recourse, Non-Recourse, Partial Recourse – Full Recourse means that if the loan goes bad the Guarantors are responsible for the entire unpaid balance.  Partial-Recourse sets a percentage or cap on the obligation of the guarantor, and Non-Recourse means that if the loan defaults the only recourse for the lender is to take the property.  When obtaining a Non-Recourse loan be sure you understand the carve-outs.  Carve outs are defaults or conditions that may cause a loan to become recourse.
  3. Multiple Guarantors – If there is more than one person signing on the loan are the guarantees several or joint and several?  Are they in proportion to the signors interest in the investment?
  4. Reserves – If the loan includes the establishment of repair or construction escrows it is important to negotiate before closing how and when you will be able to access the funds.
  5. What may constitute a default on the loan?  With commercial loans defaults may occur for reasons other than just non-payment.  Be sure you understand your reporting obligations and the consequence of failure to report.
  6. When you have found a potential lender, before you start spending money, it is important for you to understand the lenders interest.  Has the lender actually committed to fund the deal or have they only provided a non-binding term sheet?  If they have made a commitment it will be subject to conditions.  It is important for you to understand the conditions and determine if they are items within your control.
  7. Timing  – Is it reasonable for the lender to close your type of loan within your contract deadlines.  What targets will you need to meet for that to happen?
  8. It is important for you to understand going into the loan if the committed amount can be reduced for any reason.
  9. Are you prohibited from subordinate borrowing?  If you are prohibited from borrowing additional funds after the close of the loan be sure your first position note is sufficient for not only your purchase but also any repair or construction funds that may be needed.
  10. Is the lender taking control of management?  Some loans will state that you must have professional management and that the management may not be changed without the lenders approval.
  11. Are there any prepayment or defeasance penalties and if the loan is assumable what are the requirements and the assumption fees.
  12. Exit Fee – Yep you guessed it! Some loans require a fee at the time of payoff.

I encourage everyone to practice your loan due diligence to compliment your physical and financial due diligence to curb your uncertainty and fear.

   Fear defeats more people than any other one thing in the world.

 Ralph Waldo Emerson

 Conquer the fear and prove yourself a winner.

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One response to “Real Estate Loan Due Diligence

  1. ROBERT TIMMONS November 26, 2013 at 11:57 pm

    THANK YOU I HAVE FINLY GOT A CHANCE.

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