Denver Commercial Real Estate Lending from a Banker’s Perspective

The Canon Property Group at Your Castle Real Estate is a small team that has built its business by understanding our customers’ needs and objectives and finding either buyers or sellers for them. The commercial market today is a seller’s market. We receive between 4 and 6 unsolicited, out-of-state inquiries every day from investors seeking opportunities in this very hot market. As a result of that interest we researched the number of transactions in 2017 in a narrow value range of $2.5 million and $5 million and discovered there were 237 transactions in the Denver MSA with a total sales volume of $818,000,000.

That tells us there is a lot of opportunities in that segment. For every commercial transaction you see in the news, those 85 million-dollar apartment complexes, there are 20 transactions that didn’t make the news that are done by people who are everyday investors. These Mom and Pop investors are folks who have saved some money, bought a building, and sold it 20 years later, and retired. Or moved up to a bigger asset through a 1031 Exchange.

This segment is approachable by a large segment of the Denver investment community. Potential investors, who have saved some money, or who have some equity in their house, have an opportunity to get into commercial real estate investing without being one of these hundred million-dollar projects.

Commercial Lending

For these smaller investors obtaining financing is a critical component to buying real estate. In our podcast, we invited a special guest, Caleb Neumeyer, the Vice-President of Commercial Banking at Bank of Colorado to discuss commercial lending, or, “lending for a business purpose.”

“Commercial lending” doesn’t mean that you have to be a business to borrow money from a commercial lender. But if you’re buying an investment property and want to use financing, that’s where Bank of Colorado enters and there are a lot of different financing tools that anybody can use to buy their first, second, or 10th investment property.

Most people are familiar with the residential side of real estate and the financing that goes with it.  But commercial lending is much less-regulated than residential lending. In residential lending you have a host of boxes that you need to be able to check off; whereas in commercial, the bank has a lot more authority to apply its discretion in the underwriting of the deal. Each commercial lender can evaluate the risk according to its own criteria.

The debt service coverage ratio (DSCR) is the beginning point in the Bank of Colorado risk assessment.  Does the property cash flow? Are the projections for rent reasonable? Is there a sponsor behind the project that can support the debt payments should the project not perform as expected? A DSCR of 1.25 is the minimum. More speculative properties such as one with a higher tenant rollover risk, the DSCR might jump up to a 1.35 or sometimes a one and a half. At a minimum, the project’s rental income must cover the cost of the loan plus another 25%. Cash flow available to service debt is an easy summary.

The Loan Guarantor

At the Bank of Colorado 95% of deals require a guarantor for the loan. First and foremost, the bank looks at the property. Location, asset class, quality of the asset, and income stream are some of the items of interest. And once the bank analyzes the property and says, “You know what? The debt service coverage ratio assumptions are reasonable. The property’s in a good location. There is a long-term tenant.” Then the bank looks at the guarantor, the project sponsor, to see if they have sufficient income to be able to make the payments should the property not lease up as expected. The bank will also examine if there is excessive tenant rollover risk. All of these considerations are included in the bank’s underwriting decisions.

More specifically, the bank looks at the individual guarantors behind the deal. They look at their gross income, the total amount of living expenses, and their other debt obligations.

  • Do they have a personal mortgage?
  • Do they have other investment properties that may need support? And then the bank examines their cash and their liquidity.
  • Do they also have cash reserves where they can make a big capital expenditure if needed?

With presented with a loan request, any bank will ask, “Does this make sense? Is this a sensible deal for whoever’s buying the property?”

Sometimes the bank will do a “non-recourse” loan[1] and those are reserved for customers with whom the bank has experience. The bank knows their investment background and their expertise. If it’s a construction company, the bank will be familiar with whom they work. The bank understands the types of relationships that they have with contractors.

If the borrower has a property with “national tenants,” Like CVS or Walgreens, with a corporate lease guaranteed at the corporate level, they will probably not require the personal guarantee. These types of loans are often structured so that the debt comes due prior to the end of the lease term.

At the end of the day, what a guarantee is to most banks is a show of good faith. If, for example, there’s an economic downturn and the individual investor has five properties and guarantees on two of them, he will be far more attentive to those two loans where he has the guarantees.

The Importance of the Relationship with the Bank

This is where residential loans and commercial loans are very different. With residential mortgages, if you do six loans for six different homes, you still have to provide all of your income qualification documentation. It’s a hard and fast rule. With commercial lending, you still have to provide those documents, but your strength of the relationship with your lender is important. If a borrower has completed five commercial deals with the bank, that history gives the borrower some extra leverage to get the loan. In residential lending, that does not happen. The strength of your relationship with your commercial lending institution is important.

Asset Classification

Generally, banks look for 25 to 30% cash equity into a deal. It can be higher, depending on the quality of the property. Properties are generally classified in the three tiers, A, B, and C.  An “A” property would be a property in the very popular Denver Highlands neighborhood. Land is not readily available. A “B” might be somewhere in the Metro Denver outskirts. A “C” property might be an older industrial type building or property that really needs a lot of TLC. With an A property, for example, the bank would usually require 25% cash equity, or even 30%. The B or C segments require a minimum of 30 to 35% cash. If the market were to slide, C properties generally lose value quicker than an A or a B.

There has been some discussion recently in the commercial press about investors having less confidence in these A-plus downtown-core, super expensive properties, whether they be office, residential or multi-family. And they’re saying that putting your money into a B or C asset class is a better idea because if the market shifts they will be more attractive because the demand for more affordable offices, industrial, and multi-family assets goes up.

However, it’s a sensible assumption that should a market shift down, all asset classes will shift down. A’s will become more affordable. The B’s will become more affordable. An “A” property at a “B” price point will be more attractive. If an investor owns a “C” property and he can move into a “B” property the probability is that he will do so.

No matter the asset class or the location, the capability to identify areas of change and to be there before the change erupts is a basic skill for an investor in the price range under discussion. This is where the small investor can make a lot of money.

Cash Out Refinance

If a homeowner has owned his home long enough to generate equity, it is possible to use that equity as the down payment for a commercial loan. Assume an investor wants to purchase a $1 million commercial property and wants to use the $300,000 equity. The investor will have a higher debt obligation that may be covered by the cash flow of the property. The bank will still determine if he still has adequate cash reserves. For example, that same homeowner does a cash out refinance and generates a $300,000 down payment. The bank will want to know what cash reserves he has beyond the $300,000. If, for example, he has $50,000 cash and he now has 2-loans (home mortgage and the commercial property), the bank would consider that a higher risk. If, on the other hand, he has liquid bank accounts where he can fund any unforeseen needs on those properties, the bank would find that acceptable.

The market is getting tighter as the investor money becomes more active. Out-of-state money is flooding into Colorado. The squeeze is on. Cap rates are falling and mortgage rates are increasing. With mortgage rates at 5.5% for commercial loans, an investor needs a project with a cap rate of at least 6 to make sense.

Commercial Loan Structure

The most common structure is the 25-year amortization of those Class A and Class B properties. Loans for Class C properties are limited to a 20-year amortization. The loans have a 10-year term with the rate fixed for five. It would then adjust over a spread and then fixed for years six through ten. Banks usually require a 1% fee.

Managing the Cash Requirements

It is important for the investor to identify through a property condition report and various different inspections the most probable cash requirements.  Is there a deferred maintenance issue? Does it need a new roof? How’s the HVAC system? Is the boiler shot? Is there sufficient cash to perform the surveys and environmental Phase I and Phase II testing? Those costs, if identified before the purchase closes, must be negotiated. The investor must understand the condition of the property is and the income it currently generates and whether or not there’s an opportunity to improve both. The bank will look at if there Is an opportunity for this specific asset to increase in value.

If you’re an investor looking to go buy an eight-unit apartment complex and the apartment complex has a lot of leases coming due and you see a lot of opportunity to go put in new kitchens in each unit and then re-lease the property, the bank will structure a loan that gives you a first-year interest-only payment. This type of loan which gives the investor the flexibility to make those upgrades, re-lease the property, and then begin to pay down the debt via amortization. Interest-only periods, as long as they’re sensible and they’re lined up with a purpose for the property, are commonly used.

Common Mistakes that Investors Make

One of the most common mistakes is for investors to pursue too much leverage to maximize their cash-on-cash return. The higher you leverage a property the more susceptible that property becomes to market swings. Because the margin for operational error or reduction in operational efficiency becomes a lot smaller. Another is Underestimating day-to-day expenses. Rookie investors need to be real with themselves and look at what their expenses truly are and get a really good snapshot of what they spend, what they earned, and what they have.

From the commercial real estate brokerage side of the equation, inexperienced investors want to make changes to properties that do not generate a return on their investment. For example,

rather than installing a dollar per square foot tile, they put in the five dollar a square foot tile because it looks better. However, the asset will not rent for any more money. You have to be extremely disciplined when it comes to decisions about how to spend the money.

Frequent Questions from Investors

  • What’s the value of being close to a light rail stop?
  • What kind of employers are coming into the market?
  • Where are the tech companies locating in the city?
  • Who are the biggest employers and who is growing currently?
  • Where are they locating?

There is a massive influx of money going into properties near the airport. There are tech companies that are big and growing in Broomfield, for example. There are aerospace and aeronautics down in Centennial and Littleton. Some parts of Littleton and the surrounding area are pretty attractive from an employment standpoint. For investors these types of decisions are first driven by the price range type and asset class. Once those are known, the location decisions follow.

The bank gets questions about location and price.

  • What areas do we think are a little bit overpriced right now?
  • What areas do we see opportunity in?

And then there’s kind of market fundamentals. When it comes to construction, we are often asked about trends in construction cost inputs such as labor, framing, etc. The advantage the bank has is that it sees hundreds of deals a year, whereas an individual investor, and institutional investor even, is looking at more of a limited scope.

When to Talk to the Bank

The bank likes to speak with clients once they’ve done their due diligence and they really know not only what they can afford. They should know what area and asset class they want to be in. If somebody wants to call and just kind of walk through the iterations of, “How does a deal work from the bank side,” the bank will be happy to do that. But once an investor is truly looking for specific financing, then the bank will gather the personal financial statement. Generally, it’s a good idea for anybody looking to enter the market should be writing down all of your assets and liabilities.

Once that is done, the investor must choose the right bank for him. An advantage of a local bank is speed to market. What Bank of Colorado does really well is generating a quick turnaround time on deals. That capability from the internal business processes than decide on loan approvals. The credit committee has flexibility in response time and is structured so that the client benefits. The person loan officer that initially is assigned a client, manages his deal until the end. The bank sees that process as valuable because the bank tends to know the projects better and the borrower knows the bank better. If there is an issue, the rapport is already built.

Long-term View of the Denver Market from the Bank’s Perspective

Denver has strong population growth with sub-3% unemployment. The state budget is healthy. Colorado has competitive tax rates and a really good quality of life. The influx of new companies is strong and the creation of new companies is robust.  Recently HomeAdvisor, Slack, Strava, VF Corp., who owns North Face, have all announced expansion in Denver.

While home prices are going up, wages aren’t necessarily keeping track. At some point rents will consume a disproportionate percentage of income. Expect a slower growth rate than what Denver has experienced recently.

Case Study: Specialized Industrial Warehouse

Canon Property Group has a listing on a warehouse in North Denver.  It’s a meat packing warehouse with all refrigerated space. It’s a 35-year-old building with a business tenant that  has been in operation for 30 years. The lease has four years left with an additional five-year term after that. The income on the property is $150,000 net per year. The asking price is $2 million. It is a 9,500 square foot warehouse with an additional 4,000 square feet in the basement. At the asking price of $2 million, that’s $200 a foot for the warehouse and a seven and a half percent cap rate.

How would the Bank of Colorado look at that from a lending standpoint? Is the cost per foot of the building an issue? How do you consider the business that’s been there for 30 years? What is the importance of the $17 per square foot lease rate and the seven and a half cap?

“You know what you know, and you don’t know what you don’t know.”  What we do know is that we have a tenant that’s been there for 30 years. They have four years left on their firm term lease. And then after that, they have a five-year renewal option. The 30-year history is great. Remember when we structure the term of a loan it’s five-years fixed and fixed again for year six through 10. We would look at the rollover risk and what is the probability that this tenant will remain after the four years and then execute on the renewal option? In this case it appears the odds are pretty high, they’ve been there; it sounds like that location is working for them financially. That would be generally a positive story for our assessment.

From there we would ask, “Should this tenant choose to vacate for whatever reason, what is the probability that we can get a tenant of a similar quality in? Are they willing to pay the same rents?” We would want to make sure that the lease rate is the market rate. Refrigerated warehouse space is really desirable right now. Especially as you continue to have the population growth that we’ve seen. That’s an asset class that if you can find it, there tends to be premium on it just because it offers an advantage that’s expensive to build out. By already providing that functionality to a buyer or a user that’s coming in, you can charge a premium for it. Demand is high and supply I slow.

If you’re a commercial kitchen user or a meat packing business, and you don’t own any real estate, you need to rent it. You have two choices. Number one, you can go to a regular warehouse and retrofit the building to your needs. Instead of just walking in and paying $12,800 a month in rent, you’re walking in and spending $150,000 or $200,000 or $300,000 upfront and then you will still pay $10,000 per month in rent. You might have a higher rental rate, but you have less cash up front and less time to wait to enter the building.

Bank of Colorado is at 1801 Broadway, right across the street from the Brown Palace. The branch phone number is 303-308-0000. Caleb can be reached via email at


[1] If the borrower were to default and the asset does not sell for at least what the borrower owes, the lender must absorb the difference and walk away; he has no claim on the lender’s other funds or funding sources. (

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