The commercial real estate financing industry is highly fragmented, with multiple product types depending on the type, size, location, value and income-generating potential of the property in question.
In many cases, traditional financing might be warranted.
Yet there are plenty of other cases in which alternative financing mechanisms, like asset-based lending, are not only worthwhile—but necessary.
Asset-Based Lending for Commercial Real Estate
In this article, we take a look at asset-based lending in CRE, a type of financing that is used less frequently than some of the other CRE loan types available today, but one still very worthwhile to CRE investors in certain circumstances.
What is asset-based lending?
Asset-based lending is an alternative form of financing that leverages a person’s (or company’s) assets as collateral to obtain financing.
Typically, a company’s inventory, equipment, machinery, and accounts receivable are used as collateral.
In some cases, commercial real estate can be used as collateral, as well, but asset-based lenders prefer collateral that can be quickly and easily liquidated (such as securities).
The collateral is what provides the lender security that they will be repaid in the event the borrower defaults on the loan.
Asset-based loans are generally considered a form of hard money loan, which tend to carry higher than average interest rates.
Most asset-based loans are structured as revolving lines of credit, though they can be structured as term loans as well.
When is asset-based lending typically utilized?
Asset-based lending can be utilized in a variety of circumstances. Most often, asset-based loans are used by small and midsized businesses (SMB) that are asset-rich but cash or credit-poor.
As a result, they may not be able to get a loan from a traditional lender—certainly not in the timing they’d likely require.
For example, an experienced chef may decide to go out on his own and open his own restaurant.
He has partnered with another chef who has recently closed her restaurant and now, they’re looking to get a line of credit to jumpstart their new venture.
Because they’re still in the startup phase, they don’t have cash flow, profitability, or anything other than revenue projections to point to.
Their personal credit scores are mediocre and neither have enough cash in the bank to give traditional lenders comfort in issuing a business loan.
However, the partner who closed her restaurant has the benefit of owning hundreds of thousands of dollars’ worth of kitchen equipment that she can put up as collateral.
In this case, an asset-based loan fits the bill.
The partners are able to use the proceeds from that asset-based loan to fit out their new restaurant space.
Asset-based lending is also utilized when a borrower needs a flexible financing solution.
Because loans are often structured as lines of credit, borrowers only need to repay the loan if they actually draw on that line of credit (versus term loans that must be repaid in full, plus interest, whether the loan is used or not).
This is a great option for a company that may have intermittent needs, such as investing in additional inventory during a busy season or supplementing payroll during a slow season.
Why do CRE investors use asset-based loans?
Commercial real estate investors will often utilize asset-based loans when traditional financing is not an option, for one reason or another.
Perhaps the investor has bad credit, or worse, has lost a previous investment property to foreclosure.
Perhaps the investor wants to buy non-traditional real estate, such as a property that will be utilized as a short-term rental offered for rent on websites like Airbnb or VRBO.
Because asset-based loans focus on the value of the underlying asset as collateral, the borrower’s personal financial circumstances and/or how the property will be leased is of less importance than the value of the asset itself.
Consider the case of an investor who wants to develop a built-to-suit industrial property that will be fit-out for company specializing in cannabis cultivation.
Because cannabis cultivation is still prohibited at the federal level, and because most traditional loans contain language that stipulates a borrower abide by all local, state and federal laws, leasing the space to a cannabis company could result in the borrower defaulting on the loan – if the borrower were to get a loan from a traditional lender.
Instead, the investor might instead look to borrow from an asset-based lender, where requirements tend to be less stringent and where the loan would be tied to the value of the asset (in this case, the industrial real estate).
This is actually a really common scenario for CRE investors, particularly as consumer preferences are changing.
For example, the growth of e-commerce has had a major impact on demand for big box retail. Millennials, in particular, are doing a bulk of their shopping online and then filling the gaps by purchasing goods from locally-owned retailers.
Commercial real estate developers have responded by creating food halls and other “hubs” of micro-retail, where retailers can lease as little as 150 square feet of space.
This model allows entrepreneurs to experiment in a low-risk way prior to opening their own larger, independent storefront.
Consider Bow Market in Somerville, Massachusetts.
Two entrepreneurs purchased a self-storage facility with the intent of converting each bay into a small retail store.
The project is anchored by a brewery, but that brewery is also new to the market and this is the brewery’s first location.
The driveway to the former self-storage complex was converted into a vibrant public plaza, with regularly-programmed events and activities.
Today, Bow Market is a hub for small, independent retailers from throughout the Greater Boston region.
The challenge is that a concept like Bow Market is difficult to finance.
Sometimes the project has a credit-worthy anchor tenant, but most often, the businesses moving to these locations do not have an established track record (including revenue, lease payments, etc.) to satisfy traditional lenders’ underwriting processes.
This was a big challenge when “coworking” took the real estate industry by storm.
The concept, in which individuals or companies pay a daily, weekly, or monthly fee to operate out of a shared office space, was entirely new and for a long time, unproven.
Traditional lenders did not know how to underwrite these projects, as the revenue did not fit the normal long-term lease mold.
Projects like these are all ideal candidates for asset-based loans. For instance, the Bow Market project is located in a dense, urban environment where property values have skyrocketed.
The property is of tremendous value to an asset-based lender, and therefore, would make excellent collateral if Bow Market needed to secure an asset-based loan.
(Note: it is unclear what type of financing Bow Market used—this example is for illustrative purposes only.)
Lastly, CRE investors utilize asset-based loans when time is of the essence.
Asset-based loans tend to require less paperwork and have fewer restrictions than traditional loans.
This allows an investor to tap the value of their physical assets when they need quick access to cash for any reason – ranging from a sudden roof repair, to an opportunity to buy off-market real estate for cash.
In summary, CRE investors most often utilize asset-based loans in the case of:
- Poor credit.
- Needing flexibility.
- Needing quick access to funds.
How does asset-based lending work in CRE?
The terms and conditions of an asset-based loan depend on the type and value of the collateral offered as security.
In most cases, businesses can borrow anywhere from 75% to 85% of the value of their accounts receivables but only about 50% of the value of their inventory or equipment.
The reason for that is because inventory and equipment can be harder to liquidate.
And with technology and consumer preferences changing so rapidly, inventory and equipment can quickly become obsolete (thereby reducing their market value).
Qualifying for an asset-based loan is often easier than qualifying for a traditional loan, but there is still a robust process involved.
That process often entails paperwork, interviews, and sometimes even requires a site visit to evaluate the condition of the assets being used as collateral.
The process moves fastest when there is a single asset being used as collateral, such as a commercial property, versus multiple assets being put up collectively as collateral.
In terms of financials, an asset-based lender will typically want to see the company’s balance sheets, profit & loss statements, sales forecasts, tax returns and bank statements.
To streamline the application process, CRE investors should take the time to gather this paperwork in advance of approaching an asset-based lender.
CRE investors will also want to create an inventory of any assets that might be proposed as collateral, as well as estimates of those assets’ fair market value. The best assets to use are those that are owned free and clear.
Once this paperwork has been compiled, a borrower can submit an application to the asset-based lender, which will formally kick off the due diligence process (and will include things like the site visit mentioned above).
CRE investors should expect rates on asset-based loans to be slightly higher than conventional loans, but slightly lower than hard money loans.
Rates typically range from 7% to 15%, but can vary depending on the type and value of the collateral, as well as the financial position of the borrower and loan term.
Who are some of the most prominent asset-based lenders?
The asset-based lending market was once dominated by private lenders, but increasingly, traditional banks have begun to offer asset-based lending as an option in their financing toolkits, as well.
For instance, Wells Fargo now offers asset-based lending to middle-market companies and large corporations in the U.S., Canada, U.K. and beyond.
Other asset-based lenders include:
GUD Capital will consider a wide range of assets to be used as collateral, including:
- Accounts receivables
- Commercial real estate
- Personal real estate
- Equipment and machinery
- Bank accounts
- Credit card processing amounts
CoreVest provides asset-based loans for CRE investors of all kinds, ranging from rental loans (1-500+ unit apartment buildings), bridge loans, and multifamily/CRE loans.
Alignment Funding Group
Alignment Funding Group is a private lender that offers a range of financing tools (designed to align with your specific needs), including asset-based lending for CRE.
Asset-Based Lending Software
For lenders interested in offering asset-based loans, having proper systems in place will go a long way in determining the likelihood of loan repayment.
There are several asset-based lending programs on the market today that help lenders track the value and liquidity of collateral over time.
Software can also help asset-based lenders process loans, calculate interest, produce timely reports, and identify potential delinquencies prior to default.
A few of the more popular asset-based lending software programs on the market today include:
ABLSoft, a web-based platform that allows for flexible monitoring of loans from anywhere at any time. ABLSoft is often used to improve risk management and decision making processes.
Cync can automatically calculate all ineligible accounts receivable, inventory, collateral values and BBCs from their collateral details.
FinSoft, which offers multiple products to assist asset-based lenders improve operations and provide audit efficiencies.
For investors and lenders-alike, asset-based lending could be something we see more of in the future, as more and more lenders offer such options.
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