How Can Your Commercial Condominium Association Increase its Chances of Qualifying for a Loan?

How Can Your Commercial Condominium Association Increase its Chances of Qualifying for a Loan?

Fri, 24 Jun, 2011 at 11:53
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By: Frank Coleman and Anthony Dister

I am sure you have all heard that Banks are not lending money and that financing is very difficult to obtain these days; however, this is not the case for well run Commercial Condominium Associations. Rather these loans, if underwritten properly by a financial institution with experience in this market, are relatively safe, low risk investments for the Bank which typically pay off early and rarely go into default when properly monitored.  In order to be considered well run, Boards should conduct their Commercial Condominium Associations as a business and plan for future capital expenses. A watchful eye should always be kept on the bottom line because when applying for a loan, the Commercial Condominium Associations must be able show the ability to repay the debt and demonstrate a history of financial stability. 

So how can a Commercial Condominium Association qualify for a loan?

The best way is to be prepared for the loan application process and be aware of some of the items the Bank looks at when reviewing requests. These include the steps taken in planning for the project, average value of the commercial units, number of units, delinquent payment of assessments, contingencies for bad debt, assessment levels, owner occupancy ratio, insurance, pending lawsuits, association’s ability to service debt, repayment plan, deposit relationship, reserve funding, as well as other items. These are looked at as follows:

Taking the steps to appropriately plan for a major capital expense that requires financing not only shows the Bank and commercial unit owners that the Board is exercising its fiduciary duty but also ensures the financial impact to the Association is minimized. The Bank may need to know how the scope of work was identified, the duration of the planned repairs, and how the professionals completing the projects were selected. The Bank will typically require copies of the contracts for the work to be performed prior to funding on a loan and that these contracts have been properly executed and reviewed by counsel when appropriate. Depending on the size of the project, a third party engineer or architect may be required to supervise the project and approve all advances on the loan and payouts to contractors. The Commercial Condominium Association should surround itself with qualified professionals and plan accordingly to ensure the project goes smoothly and is completed correctly.

Average unit value and number of commercial units is taken into consideration to determine if the size of the loan requested is reasonable for the Association. For example: a 25 commercial  unit building requests a $1,000,000 loan and the units are valued at $250,000 each; this comes to $40,000 per unit or 16% of its value which would be considered high. Assuming a 36 month repayment, the monthly amount due would be over $1,111 per month not including interest or regular assessment payments. This scenario could dramatically increase the likelihood of non-payment of assessments and possible default on the Association loan. This is why it is imperative that Associations reserve funds for future capital expenses to potentially reduce or eliminate the need to take out a Bank loan. In this same scenario, an association that is able to pay for 50% of the project from reserves and finance the remainder reduces the financial impact to owners and increases its chances of obtaining a loan.

The collateral for a Commercial Condominium Association loan is future assessments and assets of the association. Most Banks have guidelines regarding delinquent assessments which Associations must meet in order to qualify for a loan and maintain while the loan is in place.  These guidelines are typically no more than 5-10% of the total number of units delinquent on assessment payments and no more than 5-10% of the annual assessment income delinquent more than 61 days past due at one time. If the assessments exceed these limits a default could be triggered which could result in action by the Bank. Prior to obtaining a Capital Improvement loan, an Association should establish a delinquency collection policy and stick to it. The Association’s assessment income is the Bank’s source of repayment so the Association must be diligent about collecting assessments. Delinquent accounts should be turned over to the Association’s attorney as soon as the policy allows for it.

Commercial Condominium Associations considering taking out a loan should incorporate a bad debt reserve or contingency for bad debt into their operating budgets. In the event there is non-payment or late payment of assessments while the loan is in place, the contingency for bad debt will help to ensure the association has sufficient cash flow to meet its debt obligations and run its operations.

In the current market environment, where unit owners go out of business and are not able to pay their monthly assessment fees, the Association may foreclose on the property and rent out the unit in order to cover the assessment payments.  If the Association is unable to rent the unit out, this may place a burden on the other unit owners to cover the decrease in monthly assessment fees.  In order to minimize the financial risk, prior to loaning the dollars to the Association, the Bank may evaluate the unit owners in the Association as to their financial conditions by requesting certain documents, such as financial statements.

Assessments should be raised on an annual basis at least 3-5% or what is reasonable for the Association even while the loan is in place. Expenses go up every year so assessments should too. Raising assessments annually will help provide the Association with the funds necessary to continue to pay the Bank loan and its other operating expenses.

Prior to applying for a loan, the Board should review how many non-owner occupied units there are and are allowable within the Association. Most Banks that provide Commercial Condominium Association loans have guidelines in place that limit this number in order to qualify for a loan. These limits can range from no more than 20-30% of the total number of units in an association that are leased. This limit is put in place due to the risk involved and uncertainty of investor owners’ ability to pay their monthly assessments and/or special assessments.  

Commercial Condominium associations are required to carry adequate insurance per the Illinois Condominium Property Act and the Bank will require proof of this insurance as a condition of the loan. Insurance will be required to be maintained while the loan is in place and the Bank will typically require they are added to the policy as additional insured or other clauses. Boards should review their insurance levels annually with a qualified association insurance professional.

Lawsuits in which the Association is involved not only complicate matters for commercial unit owners trying to buy or sell units but can also inhibit the Association’s ability to obtain a loan. A lawsuit against the Association may impact the ability to repay its loan due to increased unbudgeted legal fees or the potential that a large settlement payout is required. Association Board’s should try to resolve these matters as quickly as possible and move on with the day to day operations of their association.

Prior to applying for a loan the Board should have a repayment plan in place or in mind. They need to take into consideration how it will affect unit owners and try to resolve any issues that may arise before it is implemented. Communication with owners is critical in this stage as it may affect them directly. Association loans are typically repaid from an increase to regular operating assessments, special assessments, reserves, or a combination of these items. The board must decide which option is best for the Association as a whole. 

The association’s existing or pending relationship with the Bank is also taken into consideration. The Bank will be looking for deposits to be maintained with them while the loan is in place; this may include operating and reserve accounts or a predetermined dollar amount. This is done to provide additional security for the loan and establish more of a relationship with the Bank.

During the loan, the Bank will look to the Association to continue to contribute to its reserves or fund other capital projects not included in the loan. These projects can be identified by completing a reserve/engineering study, following it, and keeping it up to date. A reserve/engineering study by a reputable firm may be required depending on the size of loan to determine what repairs may arise while the loan is in place. The Bank can then work with the board to incorporate these projects into the current loan, postpone them, or help plan to reserve for them as they could impact the ability to service the existing debt. While many capital projects are extremely expensive, being able to self-fund a portion of these projects eases the burden on unit owners and may help the Association obtain financing for the remainder if required.

The above are some of things that Banks looks at when associations apply for loans; this is not a full list but can be used as guide and best practices checklist. Preparing for the loan application process increases the Commercial Condominium Association’s chances of being approved and obtaining the loan.