Understanding Commercial Real Estate Investing

The first factor involved in determining whether an individual will make an ideal borrower is his character. Because most small businesses do not have an established track record in their own right to provide credibility, we look into the history of the business owner to determine stability and ability to make good on the loan. Factors that are commonly evaluated include things like personal credit history, personal financial strength, relevant experience, and track record in the business and industry. An individual’s credit report plays a key role in this as it provides an in-depth look into the individual’s financial history and how he has handled debts and recurring payments in the past. Each reporting agency, or Credit Bureau, will provide a slightly different overall rating, which may be called a credit score or FICO score (named after the software developed by the Fair Isaac Corporation that many reporting agencies use). However, they all signify the same thing. On a scale of 300 to 850, those who manage their debts well have higher numerical scores and those with troubled financial histories have lower scores. Lenders will all have a different minimum FICO score threshold for borrowers, and it may also vary from one loan package to another.

AVANA Capital favors small-business owners who have invested in their own companies. By measuring personal capital, we can assesses the entrepreneur’s ability to repay the loan in the event the business does not meet its financial goals. It may also be referred to as “net worth,” which is an individual’s total assets minus his liabilities. Assets can take the form of an initial cash infusion, retained earnings, a car, real estate, cash, investments, savings, or other resources that the business owner may be able to draw upon if necessary to repay the loan.

Of equal importance is a borrower’s “capacity” to repay a loan. AVANA will examine all of an individual’s personal and company debts and expenses and will then compare them to cash flow. When the ratio of debt to income is smaller, it signals to us that the borrower will have the ability or capacity to make payments. We will look at a company’s historical cash flow to help estimate what it will generate in the future as well as personal information, such as past income, type of income, and employment history.

There are two main types of debt: secured and unsecured. With unsecured debts, the lender relies solely on the borrower’s promise to repay the loan. This is common with smaller debts, such as when a credit card is issued to an individual who has a good credit history. Most other types of debt, such as auto loans and home equity loans, are secured by some form of collateral. This means that the borrower promises to relinquish ownership of something of value, be it the vehicle or home in the aforementioned instances, if he’s unable to pay on his debt. Because the value of collateral may change over time, perhaps through depreciation of aging technology and equipment or as a result of a fluctuating market such as real estate, AVANA lends based on a borrower’s cash flow rather than collateral. The collateral is only used as secondary source of repayment of a loan for Note A and Note B investors. In other words, liquidating a borrower’s assets is an absolute last line of defense and is only utilized when the intended method of payment has failed. Sometimes, it’s necessary for another party to guarantee repayment of the loan as well. This is much like having someone co-sign on an auto or home loan.

Arguably, the most subjective criteria used in determining whether a loan will be issued are the market and economic conditions. AVANA evaluates how the borrower intends to use the funds as well as how external events may influence his ability to repay the loan. For instance, companies that rely heavily on the transportation of goods and people will have a surge in expenses if the cost of oil spikes quickly. Equally, the competitive environment, and how the business in question performs compared to its competitors, will be analyzed as well. This way, we can determine how the business will be impacted if a competitor moves in or what might happen if a leading source of consumers leaves the area, finds another supplier, or cannot afford to make purchases and payments.