Financing CRE in Low Cap Rate California Markets Photo by Bernard Gagnon

Financing CRE in Low Cap Rate California Markets

Financing the purchase of commercial and multifamily investment properties in top California markets typically requires some creativity to make some of those transactions possible. With many top markets including San Diego, Orange County, Los Angeles and the San Francisco Bay Area experiencing lower cap rate environments, investors commonly aren’t able to achieve the maximum loan amounts they would prefer on new investments. There are, however, a few solutions to help mitigate the issue.

Investment properties in California can attract some of the best rates and lending terms compared to other locations. California properties historically have maintained their values through recession periods better than most markets. For commercial real estate investors looking for safer options, properties in this coastal area are a top selection. They are also a more favorable pick for banks and other lenders, who base their lending decisions primarily on the risk involved in the transaction. Rates and terms can get more aggressive for well-located properties. It’s common for many top markets in the state to have lower cap rates to compensate for the minimized risk.

A cap rate is the most common method for valuing investment properties and potential return on investment. Lower capitalization rates are derived by either lower net operating income (NOI) or increased property value. Generally speaking, investors purchasing these properties are willing to take a lower NOI or pay a higher price, in return for the reduced risk of the investment. That higher purchase price means a higher loan request, and the lower NOI translates into less income available to service that debt. This is the point of due diligence when many investors realize that cap rates have a direct correlation with loan qualification.

If an investor doesn’t have the required funds to purchase the property, there are a few financing options worth evaluating that can provide a viable solution: working with a specialized lender that can provide aggressive underwriting, taking on an equity partner or securing a bridge loan.

Specialized lenders: There are a variety of lenders in the capital markets that are either not available directly or that go untapped by commercial real estate investors. Each of those lenders has a different specialization and can get aggressive on underwriting if the request fits their box. Rate reductions, minimizing the required Debt Service Coverage Ratio (DSCR) and breaks on the underwritten NOI can many times squeeze out enough loan dollars to do the trick.

Equity partners: Arranging to bring on an equity partner into the transaction can provide outside capital to fill the gap between what an investor is able to deploy and what’s needed. If the partner is a strong sponsor, this can also lead to improved rates and terms. Partnerships can also help spread investor risk while preserving liquidity. If structured correctly with a like-minded investor, this strategy can open many doors.

Bridge capital providers: Bridge loans are short-term loans used to provide capital during an interim period until an investor can stabilize the property and qualify for permanent financing. For our purposes, a well-negotiated bridge loan with the right lender can provide the full requested loan amount even if the current income is not sufficient to service the underwritten debt by conventional lenders. If current rents are under market, a good management plan and exit strategy can help secure financing to lock down the investment property.

Colin Dubel is a commercial mortgage broker and associate director with Charter Capital Group based in Orange County, Calif. He can be reached at [email protected]