Underwriting relies on a lot of math and data. Lenders measure an asset’s performance, market data that may affect the future of that performance, and the borrower’s financials. There is a lot of documentation collected to originate your typical commercial mortgage, plus an official, third-party expert’s valuation of the property (the appraisal). A loan can be rejected if the math and data show that it’s not a suitable return for the lender’s risk profile.
But it’s not just numbers that determine if the deal is made. There’s a soft side to the business, and to navigate the real estate investment industry successfully, you’d do well to understand it.
Here are some common reasons your loan application will be rejected that have nothing to do with math.
Time is money. Lenders, even those who are organized and efficient, only have so much time to work on deals. The calculation in every lender’s head, whether they realize it explicitly or not, goes a bit lit this:
You are not in a favorable position here if you’re one of the smallest loans the lender would consider while also being one of the more difficult to work with. Difficulty could be driven by the nature of the deal’s complexity, or it could be based on the personality of the borrower.
If a borrower is difficult to work with and refuses to share critical information in a timely manner, that means two things: Time Required is going up, and Probability of Reward is going down, reducing or eliminating the value in that relationship. It’s actually good thing when relationships operate this way, because it means that human beings are maximizing the value for their time, our only truly irreplaceable asset.
Quick tips to avoid your deal being labelled “more work than it’s worth”: be respectful of people, be respectful of time, and be honest.
Lenders that originate loans for their balance sheet (meaning they plan on keeping the whole loan for their own account, rather than selling or securitizing it). Lenders typically want to diversify their portfolio of loans to spread out the risk exposure.
Diversification happens on a few different levels, typically maintained by a lender’s credit team:
If a lender tells you they are full, or almost full, for the type of loan you are seeking, they may not be the best fit for the deal even if they don’t reject it outright, because there could be a lender more hungry for your deal.
I recently had a lender tell me, “we don’t take 50/50 chances”. He was talking about lending to sponsors that didn’t have a significant enough track record to ensure that their deal is a safe bet. If all you’ve ever owned is single family homes as rentals, and then you ask for a loan on a big multifamily property, a lender will see that as a risk — a risk that you’ll make mistakes and put the deal at risk of default.
This risk is actually more accentuated in commercial properties outside of multifamily. Leasing office, retail, or industrial space to companies is a very specialized skill that doesn’t naturally occur outside the bounds of prior experience.
Experience can also be relevant to other aspects of a deal, like geography. If you’ve developed an asset in Atlanta and then decide to build something in New York, you may be in for a few surprises through the zoning, approvals, permitting, and construction process. Lenders don’t like soaking up that kind of risk, so they may reject your deal because they simply weren’t comfortable handing you money, despite what a spreadsheet indicates.