Pre-qualifying Commercial Buyers?

When we hear the question “have you pre-qualified your clients?” in a residential transaction it usually means that your buyer has been in touch with a lender, submitted their personal financial statement and received a “pre-qual” letter from the bank. This letter would state that based on the buyer’s financials and their job income, they are capable of purchasing something in the $xxx range.

But in a commercial transaction it doesn’t happen like this. Since commercial deals are almost always based on the financial performance of the business and analysis of the net operating income, until a buyer can submit the financial statements for the business they’re interested in pursuing, the lender can’t give them any type of pre-qualification.

What we, as buyer brokers, do is we vet our buyers to determine what their available cash will be for a downpayment, what their cash reserves might be so that we know realistically what property might or might not work for them. Not what price range necessarily (as in a residential transaction) but what their  available cash for downpayment might afford them.

While a $250,000 downpayment might afford a $750,000 if the property’s NOI is high enough, it might better afford a $1,000,000 property if the NOI is strong enough. Here’s an example:

This is a scenario I have with current buyer clients of mine. They wanted to put down a good chunk of money on a lower priced property to not have a large mortgage. But with a lower priced property often comes a lower gross income and lower NOI. So here are two properties where their $250k downpayment shows a much better cash flow (owner paycheck) if they purchase ABC Inn over XYZ Inn. We can also see that if they put much less than $250k down on XYZ Inn, the DCR would be too low, in other words, there wouldn’t be as much to cover the mortgage and give the owners money to live on and the banks want to see this DCR in the 1.25-1.3 range. That was explained in greater detail in a prior blog post.
So ultimately, you (buyers) want your money to work for you. The best way to do this is to tell your broker what you have for available cash. Your broker will discuss what you can afford based on the performance of each business you inquire about. So focus will become “what is the gross income?” and “what is the NOI?”, not really “what’s the asking price” or whether or not you are pre-qualified for a purchase. Your broker will be able to tell you and other listing brokers if you are qualified to purchase ABC or XYZ Inn.