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Obtaining Financing For CRE Projects Part II: Understanding The Five C’s Of Credit

This post originally appeared on Southpace Blog and is republished with permission. Find out how to syndicate your content with theBrokerList.

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Obtaining Financing For CRE Projects Part II: Understanding the Five C's Of Credit

The five C’s of credit established a thorough system of checks and balances that weighs each component to gauge the potential for borrower default as well as the overall possible risk of loss for the financers. Understanding the five C’s of credit can help you determine your current credit status as well as determine your eligibility for a commercial real estate loan.

Understanding How The Five C’s Impact Your Ability To Borrow Capital

Today’s lenders have learned from their predecessors’ (as well as their their own) mistakes. As a result, most banks and larger loan institutions have implemented what’s known as the “five C’s of credit,” which includes:

  • Character
  • Capacity
  • Capital
  • Collateral
  • Conditions

Character

Financial institutions want to lend to investors that have consistently repaid debt. This component of the five C’s is essentially the borrower’s credit history, which determines their pattern for meeting previous or current debt obligations. Beyond demonstrating the ability to pay back a loan, banks may also include analysis on:

  • Current standing in the market
  • Capability for growth
  • Experienced and knowledgeable in the industry
  • Showing a sustainable business model

During the character evaluation phase of the credit assessment, a bank may ask for items such as personal financial statements, personal and business credit reports, the performance of deposit accounts, bank statements, and owner resumes.

Capacity

Also known as cash flow, capacity determines a borrower’s ability to repay debt. In essence, capacity focuses on whether the investment can generate enough cash flow to repay overall debt. Capacity can sometimes be called the Primary Source of Repayment. To determine positive cash flow, a borrower must demonstrate a debt service coverage ratio of 1.2x or greater to ensure there’s enough wiggle room in the repayment plan to account for anything unexpected that may impact cash flow. Lenders may ask for historical, interim, and projected financials, tax returns, and rent rolls for leased properties to determine a broad scope of capacity.

Collateral

Collateral serves as a safety net to cover unforeseen circumstances that diminish a borrower’s capacity (aka cash flow). It’s important to note that while collateral is a safeguard and protective measure, it is not meant to be a principal repayment source. For lenders, establishing a specific monetary value for collateral is essential to prove that an organization has assets of a quantifiable amount that can cover the loan in the event it’s needed as a secondary source of repayment. To gauge collateral potential, lending institutions will typically assess the valuation of the commercial real estate property, equipment and assets, depreciation, and a statement on marketable security accounts.

Capital

Capital establishes a company’s ability to sustain an economic downturn as well as gauges a borrower’s commitment to the success of the property’s enterprise. Low capital standing can mean that the investor isn’t wisely managing existing corporate interests. Lending companies typically follow the “Cash is King” mentality, generally expecting owners to contribute 20-30% of the total investment value to secure financing. Retained earnings and capital raises by private investors may be considered to gain a full understanding of total capital scope.

Conditions

Beyond a borrower’s specific financial history, it’s also essential for banks and other financial institutes to also evaluate a wide range of current external economic conditions as well. During times of economic downturn or turbulence, it may be tougher for commercial property investors to secure the financing they need, regardless of the other four C’s of credit.

Southpace Properties collaborates with commercial real estate owners to help them locate and secure their next corporate investment. Contact us today to hear more.

The post Obtaining Financing For CRE Projects Part II: Understanding The Five C’s Of Credit appeared first on Southpace Properties.

Jul 21, 2019Southpace Properties
4 months ago Best PracticesAlabama142
Southpace Properties

Alabama's largest independent commercial real estate firm.

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