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A value-added commercial real estate loan is one where you are improving the property in some manner. This includes not only renovation loans but also loans to subdivide the property, to change a property's use, like from a bowling alley to a strip commercial building, to change its zoning, like from agricultural to residential lots. Value-added lenders are usually bridge loan lenders who will make a short term, construction-like loan at rates and terms that are more expensive than a bank construction loan. Many value added lenders will lend for 18 months at LIBOR plus 350 basis points and 2 to 3 points. There may be an exit fee of 1 to 3 points as well. The first and most important underwriting test is the loan-to-cost ratio. You should add the acquisition cost to the cost of the improvements, any future leasing commissions, any legal fees, any entitlement fees, the financing costs, an interest reserve, and a contingency reserve of about 5% of the total project cost. Together these figures will equal the total cost of the project. The borrower must usually contribute 20% of the total project cost. In other words, value-added lenders will only lend up to 80% of cost. In many cases the borrower will already own the land or the building, and he may have this much equity in the property or in prepaid costs, such as architectural fees and engineering fees. If the borrower was successful in re-zoning the property, he may have this equity in the increased value of the land. If not, the borrower must bring the shortfall to the closing table in cash. The second test is the loan-to-value ratio. An appraisal ordered by the lender will determine what the property will be worth upon completion. Generally value-added lenders will only lend up to 70% to 75% of the fair market value of the property upon completion. The third test is the debt service coverage ratio. If the property will be an income-producing property, such as an office building or strip center, the property must be able to amply service the payments on a takeout loan to pay off the short term bridge loan. Many value-added lenders will require a debt service coverage ratio of 1.25 to 1.35 based on a permanent loan constant appropriate for the type of property and the size of loan. In other words, the value-added lender will ask himself what kind of lender (conduit versus bank) is likely to make the eventual permanent loan on the property and what kind of loan terms they would likely require? The value-added lender may even stress the deal; i.e., he may assume that interest rates will increase by 75 basis points during the term of his bridge loan and then test the debt service coverage ratio to make sure that the borrower will still be able to qualify for a new permanent loan large enough to pay off his bridge loan. He may further stress test the deal by assuming that the cap rates for similar buildings will increase by 75 basis points to see if the loan-to-value ratio is still acceptable. The final test is the profit test. The value-added bridge loan lender will make sure that, upon completion, the property will be worth at least 12% to 15% more than the total cost of the project. If not, the lender will worry that the borrower will not have enough incentive to complete the project.
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