As a mortgage broker engaged to procure financing, one must have the ability to determine market values, especially in a fast-changing environment. Borrowers and lenders alike rely on brokers to guide the conversation around property values, thus determining the ability to finance these assets.

While some lenders will require an appraisal, a broker’s opinion of value will hold more weight when working with a private money lender. There are two primary methods for valuing commercial real estate — the income approach and the sales approach — that brokers should thoroughly understand.

Income approach

The income approach dives deep into the financial health of a property. It is a fundamental method for appraising a variety of income-producing properties, from office buildings and warehouses to apartment communities and shopping centers.

This approach estimates value based on the current income or the future income to be generated by the property. The primary components of the income approach are the net operating income (NOI) and the capitalization rate.

“As a mortgage broker engaged to procure financing, one must have the ability to determine market values, especially in a fast-changing environment.”

NOI is calculated by subtracting all operating expenses (excluding mortgage payments) from the property’s gross income. Operating expenses include property management, maintenance, insurance, utilities and property taxes. While each asset has its own specific expense structure, it is common for expenses to range from 25% to 50% of the gross income.

Take, for example, an apartment building that collects $150,000 a year in gross rental income and has expenses of $50,000 (a 33% expense ratio). In this instance, the NOI totals $100,000.

The capitalization rate, meanwhile, represents the investor’s expected rate of return on a property and is one of the most widely used formulas to determine value. To calculate the cap rate, divide the NOI by the property’s current value. If the aforementioned apartment community with a yearly net income of $100,000 is valued at $2 million, the cap rate is 5%.

Conversely, an investor seeking to purchase a property can determine its value based on their desired rate of return. If an investor requires an annual return of 8% on the same apartment building, for example, they would divide the NOI of $100,000 by the cap rate of 8%. This would lower the estimated value of the property to $1,250,000.

Cap rate expectations

Although cap rates are subjective and are based on an investor’s required profit margin, there are generally accepted cap rates throughout the marketplace. Over the past few years, investors have typically used cap rates of 4% to 9% to determine values.

Typically, lower cap rates are used for higher-quality properties in primary markets that are considered safer and thus yield a lower return. Conversely, higher cap rates are used for lower-quality properties in secondary and tertiary markets where investors need a higher yield to compensate for the additional risk.

Since cap rates adjust based on location, demand and interest rates, it’s important to stay up to date on currently acceptable ratios. As a rule of thumb, cap rates are typically 1% to 2% higher than current interest rates, which saw historically fast upward movements from 2022 to 2023.

Be sure to reach out to local sales brokers to get a good sense of market cap rates. You should also take advantage of the research reports published by major real estate companies (including CBRE, JLL and Cushman & Wakefield) that offer a variety of market insights.

The income approach is particularly valuable for income-producing properties as it directly considers the property’s potential to generate revenue. But it’s essential to have accurate income and expense data when calculating the NOI and selecting an appropriate cap rate.

Sales approach

The sales approach (also known as the comparison approach or market approach) is another common method to determine the value of a commercial property. This approach relies on analysis of recent sales of similar properties in the same market to estimate the subject property’s value.

To begin, gather data on recently sold properties that are as similar as possible to the subject property in terms of size, location, age and use. These properties are referred to as “comps” or “comparables.” This information can be provided by real estate brokers, collected from public records, or downloaded from data aggregation services such as CoStar or Crexi.

Once this information is collected, the focus turns to the price per square foot (PSF). For example, if a similar property of 10,000 square feet recently sold for $1.5 million, the PSF is $150. Determine the PSF for each of the comparable properties and calculate an average. Once you have an average PSF, a value for the subject property can easily be determined.

While the sales approach is relatively simple and straightforward, there are a few items to consider to ensure that values are accurate. First, make sure the comparable properties are truly comparable. For example, one should not compare a property built in 2020 with one from the 1960s as the values will be drastically different.

You could have two identical buildings that are in different locations, which could equate to vastly different values. Always remember the old adage of “location, location, location,” as investors are willing to pay higher prices for real estate in better locations.

The sales approach is particularly useful when there is an active market with a sufficient number of comparable sales. Naturally, it may be less reliable for specialty properties, or ones that lack recent comparable sales data.

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Until the commercial real estate market stabilizes, it will continue to be difficult to obtain financing for transitional and cash-flowing properties. Mortgage brokers who master these valuation approaches will thrive by helping clients make informed decisions, maximize returns and secure favorable debt for their real estate portfolios. ●

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“While a price premium will be paid, there are many reasons that a broker would advise their borrower to consider a private lender. These include a quicker approval and funding time frame.”

This type of news can leave mortgage brokers scratching their heads as they try to figure out how to best adapt to a changing market. Sometimes overlooked by brokers is the fact that strategic relationships with private lenders may become the new standard, both as a reliable lending source and a way for brokers to diversify their own investment portfolios.

Private lending explained

Private lending refers to a type of mortgage financing in which individuals or private companies lend money to borrowers rather than traditional institutions such as banks or credit unions. Instead of having a fixed interest rate or terms as bank loans do, the terms of private loans are negotiated directly between the borrower and the lender. This can provide greater flexibility for the borrower in terms of the leverage, interest rate, repayment schedule and collateral.

The use of private lending sources can be beneficial to commercial mortgage brokers whose clients may not qualify for traditional bank financing for a variety of reasons. While many banks and other conventional lenders have stringent guidelines — e.g., minimum debt-service-coverage ratios or seasoning requirements — private lenders tend to be extremely flexible and often provide loans that banks would not typically fund.

Brokers choose to work with private lenders for a number of reasons, including when there is a short time frame to close, the property is in distress or the borrower has a lower credit score. To compensate for their flexibility and greater risk tolerance, private lenders charge higher interest rates (commonly between 10% to 12%) than traditional lenders.

Costs vs. benefits

While a price premium will be paid, there are many reasons that a broker would advise their borrower to consider a private lender. These include a quicker approval and funding time frame.

Because private lenders have autonomy, they don’t have mandated underwriting guidelines and are opportunistic in nature. They are able to approve loans much more quickly than traditional banks — frequently within a matter of days. Additionally, since private lenders tend to fund directly off their balance sheets, it is common for them to fund deals without the third-party reports (such as appraisals or environmental studies) that banks require.

There is also term flexibility. While traditional lending sources typically stick to five-, seven- or 10-year terms with standard amortizing schedules, private lenders can be flexible to meet the needs of the borrower. Examples include a 12-month loan with interest-only payments or a 24-month loan with no prepayment penalties.

It also tends to be easier to have a direct conversation with a private lender. These are typically smaller organizations that cater to brokers with individualized attention, including direct communications with decisionmakers. This can be helpful for brokers whose borrowers don’t quality for traditional financing or when the deal in question involves a property in transition.

Sourcing the funds

There are two common ways that private lenders are capitalized. The first is through a bank line of credit, which utilizes a financial concept of earnings from a spread. With this method, a private lender might borrow $10 million from a bank at a 5% interest rate, lend it out at 8%, and keep the 3% difference as their profit or spread. This method has been used for decades, but as rates have increased and banks have limited their lending activities, private companies are having a difficult time using this method.

Another way that private lenders raise capital is through individual investors, family members and friends who are looking to diversify their portfolios. Similar to stocks and bonds, individuals can actually invest in commercial mortgages by owning either partial shares or the entire loan. This type of investment offers an opportunity to earn stable returns with relatively lower risk compared to other types of investment vehicles.

The process of investing in private mortgages can vary depending on the investor’s preferences, appetite and available opportunities. Generally, it is done through a mortgage fund, which is set up for the purpose of pooling investor capital and lending it out. The fund does all the work associated with the loan, including origination, underwriting of the property and borrower, conducting due diligence, closing and servicing. Additionally, if an issue arises, the fund will be able to lead any foreclosure process, which can be complex, arduous and require out-of-pocket costs.

A mortgage fund allows individuals to be passive while enjoying the benefits of mortgage investing. In exchange for leading the process, fund managers receive their compensation through upfront fees or an annual spread. If a broker is looking to secure a loan from a fund, they should make sure to do their homework on the company and its leadership team. Meet with them in person and ask them to provide examples of loans they’ve closed, the number of loans in their portfolio that have defaulted and how they’ve handled foreclosures in the past.

Mortgage broker tips

In a new market where debt financing is harder to originate, mortgage brokers can stay ahead of the curve by sourcing a private lender database, understanding their lending programs and knowing each lender’s due-diligence requirements. Having foresight on these items will allow mortgage brokers to match borrowers with the appropriate private lenders.

While there are many private lenders available, they each have their own criteria for property types they lend on, available terms, rates, leverage amounts and even borrower requirements. As a mortgage broker, it is imperative to understand each lender’s guidelines to present them with the right types of deals and borrowers.

Remember that the last thing private lenders want is an inbox full of deals that do not meet their lending guidelines. Understanding each lender’s criteria will streamline the origination process, allowing for faster lender quotes and smoother closings.

Real estate is a relationship business, so mortgage brokers need to develop personal relationships with lenders through educational phone calls, in-person meetings and — most importantly — the delivery of high-quality loan scenarios. Brokers should strive to go above and beyond to assist lenders during the due-diligence process. This includes presenting a complete deal story, providing all required documentation, and coaching borrowers on expectations and loan requirements. The brokers who are willing to put in the extra work to achieve direct relationships with lenders and perform during the closing process will ensure successful times ahead.

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To thrive in a changing economy, commercial mortgage brokers must be able to adapt to a new norm in which private lenders will be a top choice for borrowers in need of capital. It is worthwhile for brokers to get to know multiple private lenders and understand their programs, origination processes and management teams. Additionally, for brokers looking to diversify their own portfolios, consider an investment in a private lender with a proven track record, an experienced management team and strong underwriting
standards. ●

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It’s no secret that lenders are scrambling to manage late-paying and nonpaying borrowers. Delinquencies and foreclosures weaken portfolios and lower property values, which push loan-to-value ratios above their required thresholds. And as commercial real estate lending continues to slow and the number of distressed properties increases, mortgage originators are increasingly likely to broker distressed debt. The brokers who are agile enough to make this change need to understand how to manage distressed debt, which is poised to be an issue throughout the coming year.

Distressed debt overview

Distressed debt is defined as a loan that is not performing as originally anticipated, and it is frequently described as either nonperforming or subperforming. Nonperforming loans (NPLs) are those where the borrower is no longer able to meet their obligations, causing a default. This category can include borrowers who haven’t made payments for a period of time, as well as those with loans that have reached maturity and are unable to be refinanced. NPLs are a significant risk for lenders and often result in portfolio losses.

Subperforming loans (SPLs) are typically categorized as loans that may not officially be in default but are not performing up to the standards set in the loan agreement. Examples include those that are past due for more than 30 days, or those that are frequently paid late. While SPLs are generally considered to have less risk than NPLs, it is equally important for lenders to closely monitor whether the borrower’s financial situation improves in a timely manner.

Distressed debt is a heavy burden for lenders to bear. It often ties up significant time and money while draining precious resources. Veteran mortgage brokers who have made it through major economic recessions in the past know that it’s common for lenders and borrowers to painfully fight it out in court for years before resolutions are reached, causing turmoil for both parties.

Working through problems

To avoid such difficulties, brokers need to address troubled assets with their clients. The first option for a broker is to educate a lender on how to work with clients to restructure troubled loans. If a borrower cannot make the monthly payments due to a rise in interest rates or a temporary tenant vacancy, for example, the lender may consider lowering the payments or delaying select payments until the payoff date to give the borrower some breathing room.

Although creative restructuring attempts are common, if the loan has an upcoming maturity date and the borrower is having trouble refinancing, the lender may consider extending the loan term to give the borrower more time. If the lender is uncomfortable with the current value of the collateral, it can request for the borrower to provide an equity infusion (also called a cash-in refinance) to mitigate the risk. A broker can work with the client to complete the equity infusion or even source a second mortgage for them to make up the gap. This move may help the client get back on track with their payments and avoid default. Since it can take months or even years to work through a foreclosure process, time is of the essence.

Although the above option is the preferred method, sometimes working with a borrower is not feasible and more drastic efforts need to be taken to address impending risk. Managing a hostile borrower who is unwilling to collaborate on solutions can cause immense stress for brokers and lenders. This is especially true for commercial mortgage professionals who entered the business in the past 10 to 12 years, a period where they were most likely focused on origination efforts rather than workout strategies.

“Knowledgeable brokers can help lenders analyze the best options to manage portfolio risk exposure and emerge from the current market cycle as unscathed as possible.”

The result is an industry that is oversaturated with professionals ill-equipped to manage the nuances of working through subperforming and nonperforming loans. The good news is that there are niche companies that specialize in servicing distressed debt, marking a light at the end of a dark tunnel for lenders that need support in times of crisis.

Special loan servicers

A lender that is experiencing an increase in troubled assets should consider bringing on a special servicer. This party can implement strategies to manage a borrower in default, or even a foreclosure process down the road.

When looking for a special loan servicer, it’s important to find one that can meet the needs of a specific portfolio (i.e., different asset classes or deal types). There is no one-size-fits-all solution to debt management, so lenders that get a head start on interviewing multiple brokers and servicers will ultimately have greater levels of success. To start, experience and expertise in dealing with defaulted loans and foreclosure processes in the markets you are active in is a must.

It also is imperative to remember that each state has its own laws regarding defaults and foreclosures, so lenders often must tap multiple regional servicers if their real estate portfolio spans state borders. Of course, having a clear understanding of compensation strategies is key. Some special servicers charge a flat fee, while others will charge a percentage of any profits gained.

Seeking an exit

For lenders seeking an exit plan, brokers can facilitate the sale of loans, which can provide immediate liquidity and eliminate risk as the lender is no longer responsible for the performance of the loans being sold. When selling distressed debt, there are multiple options, and knowledgeable brokers can help lenders analyze the best options to manage portfolio risk exposure and emerge from the current market cycle as unscathed as possible.

One option is to sell the loan at par, meaning the buyer pays the face value of the loan. For example, if the outstanding loan balance is $500,000, the buyer would pay the current lender $500,000 for the loan. There are even times when a buyer may be willing to pay par, plus any interest owed, or reimburse the lender for items such as attorney fees.

Commercial mortgage brokers will have an easier time selling loans at par if the outstanding balance involves low leverage, the property is in a high-quality market or there’s a high likelihood that the borrower will eventually start performing on the loan. For lenders selling distressed debt, this is a solid option to recoup the principal balance and eliminate any further risk.

For riskier loans, lenders may be forced to sell below par, also known as a discounted sale. In these cases, the buyer pays less than the face value of the loan in exchange for taking on the risk of attempting to recover the full value of the remaining balance.

For example, if the outstanding loan balance is $500,000 but the market perceives it as being risky, a buyer may only be comfortable paying $400,000. The buyer may require a discount for many reasons, including a highly leveraged loan, a destabilized property with many vacancies, an asset that is in poor physical condition or one that is not in a prime location. While the seller of the loan will take a loss, it may be worthwhile if they need liquidity or believe the situation will get worse if they hold onto the loan.

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Many U.S. mortgage lenders and borrowers are facing possible financial trouble. An experienced broker can be invaluable to help both parties navigate choppy waters. There is much to evaluate when managing a loan portfolio amid an economic recession, but the winners are those who have mastered the art of swift and strategic decisionmaking. For inexperienced or unprepared lenders, now is the time to shed risk. ●

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Instead of needing to raise $1 million from 10 close friends, a JV partner allows a smaller real estate owner to have one partner who can provide all the required funds.

Pros and cons

How it works

JV equity has been used for decades in the institutional lending space, but it isn’t as readily available in the private money space. This is because most JV equity providers have a minimum check size.

Annual cash flow

Time to sell

Finding funding

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Having alternative funding options such as rescue capital in one’s back pocket can make the difference between bringing a deal over the finish line or falling short at the very end.

Financial life preserver

Case studies

Moving parts

Staying involved

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Understand the basics

The key to democratizing the commercial real estate market is to educate borrowers and brokers who work in the sub-$5 million space.

Complete the stack

Hypothetical deals

Find funding

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