Understanding Asset Based Lending in Commercial Real Estate

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While looking at the various options available to raise funds from, real estate investors often have a hard time deciding upon that one best type of financing.

The commercial real estate financing industry is extremely fragmented and has multiple loan product types that vary based on size, location, nature, and an overall income-generating potential particular investment property has.

Additionally, the credit score of the borrower and their individual borrowing histories are to be considered too.

Thus, making the right decision when it comes to picking up the best type of loan financing can be a confusing one. However, considering all these factors is very essential in determining both short-term and long-term real estate success and thus one cannot risk being careless while making this decision.

While Private money loans, commercial bridge money loans, Stated Income loans are the new go-to loans as compared to their traditional and conventional loan mortgage counterparts, these loans too might not be available for few borrowers due to various reasons.

The qualifying standards for each type of loan varies and when one cannot qualify for the traditional loans or the standards set by the Private commercial real estate lenders, an alternative financing mechanism called the Asset-based lending becomes necessary.

It is not only worthwhile checking but becomes an absolute necessity in the need of the hour. Here’s a brief overview of what Asset Based Lending means in commercial real estate, and how does Asset Based Lending work.

What does Asset Based Lending mean in the realm of commercial real estate?

In a typical scenario, an Asset Based Lending financing option is used less frequently than the other regular forms of financing available today, but it is worthwhile for Commercial Real Estate investors in certain circumstances.

Asset Based Lending is one of the most important alternative types of financing available for CRE investors where an investor’s assets (or that of his company) are used as collateral to obtain the financing. In most cases, a company’s inventory, plant and machinery, equipment, and accounts receivable are used as collateral by the lenders to lend their money.

In rare cases, lenders also settle down to considering the real estate of the borrower as collateral to provide the loan but it’s not a preferred type of collateral as lenders often lookout for collaterals that are very quick and easy to liquidate. In essence, the lender should be assured that the collateral can be used to repay the loan in an event where the borrower defaults on making the loan repayments.

On a general note, asset-based lending can be considered as a type of hard money loan but carry higher than the average rates of interest and it’s availability largely depends on the ability of the borrower to qualify for the loan.

What are the typical use cases of Asset Based Lending?

Most often, Asset Based Lending is used by Small and Mid-Sized Businesses (SMBs) which are running low on their cash inflows or credit but are high when it comes to the value of the assets they own.

The owners of most small and Mid-sized businesses have poor credit scores and because they don’t have great cash balances in their business accounts too, it becomes very difficult for them to convince the traditional lenders to lend them loans. In such cases, they can always fall back upon Asset-based lending where they’ll have to provide the assets of their business as collateral to avail of a loan that they’re looking for.

The second use case of Asset Based Lending is when an investor or a businessman is looking for a flexible financing option. In case of term loans, borrowers are needed to repay the loan along with the interest rates chargeable at any cost regardless of whether they’re going to utilize the full loan amount or not.

As opposed to this, asset-based loan acts more like a line of credit where the borrower will be needed to repay the interests only when the amount has been used. That’s a great application for businesses that have intermittent financing needs like supplementing a payroll during a busy season or investing in extra machinery or inventory during a busy season.

When do Commercial Real Estate Investors turn towards Asset Based Lending?

For Commercial real estate investors, there can be three typical scenarios where Asset Based Lending form of financing makes the most sense.

Number 1 – When the investor has a poor credit

When the Commercial real estate investor has poor credit because he has defaulted on a loan repayment earlier, or has had a property that faced foreclosure or any other reason, the best type of financing to fall back upon would be the Asset Based Lending.

When an investor has a poor credit score, it is very difficult to avail traditional loans or to avail other types of commercial real estate loans from Private commercial real estate loan lenders. In such cases, asset-based lending is the best saviors as lenders who provide asset-based lending are not concerned about the credit score of a borrower as long as they feel safe with the value of the collateral provided.

In essence, the value of the asset-based collateral is the single most important deciding factor that influences the decision of the lender and everything else becomes secondary.

Number 2 – When investors need a flexible financing option

In a commercial real estate investing scenario, there may be times where traditional loans cannot be availed because the nature of the transaction is not very promising to a traditional lender. For instance: The storm of “co-working” had taken the country by shock and the private commercial real estate lenders were especially in shock.

The new “co-working” wave that was spreading throughout the country meant that small business owners, self-employed professionals, and freelancers no longer had to look for permanent office spaces to operate from.

They no longer had to rent out or lease out spaces for periods exceeding 3 months and could just do with the co-working business models where they’d only have to pay rent on a short term daily basis, weekly basis or monthly. If an investor had to invest in such co-working properties, traditional lenders would back off because they had no guarantee on the repaying ability of the investor.

However, smart investors knew that the co-working trend is something that’s here to stay and were actively hunting for alternative financing options where the lenders won’t feel insecure about lending their money to a rather new kind of situation that prevailed.

The Asset Based Lending thus became the best type of financing then as the lenders would lend their money based on the value of the property collateral that has been provided rather than worrying about the profitability of this business model.

As long as the collateral value was satisfactory, lenders who offered asset-based lending had no issues in providing loans. On the other hand, for investors – this meant that they can now borrow money based on the asset value easily and carry on their business of providing co-working business. The market is super volatile and in cases where investors cannot avail of traditional loans, Asset Based Lending is the answer.

Number 3 – When time is of the essence

Lastly, commercial real estate investors look for Asset Based Lending when time is of the essence in a situation. Asset-based lending is often very quick to process and needless paperwork, documentation or verification.

Traditional loans, on the other hand, require a lot of time for processing and will need the borrower to gather all the relevant documents in place. The Asset Based Lending allows a commercial real estate investor to quickly tap on the value of the assets they own when they need cash for any reason – like fixing that broken air-conditioned before an important client meeting is due or buying that off-market piece of real estate that is out for sale at discounted value for a short time.

How does Asset Based Lending work?

  • The terms and conditions of Asset Based Lending vary from one lender to another and is based on the nature and liquidity factor of the assets that are intended to be used as collaterals. Generally, investors can borrow anywhere between 70% to 85% of the value of the account receivables and an average of 50% of the value of machinery and equipment. The reason behind low rates for machinery and equipment is that equipment can always become obsolete thereby decreasing their market value.
  • The lenders would generally look at the bank statements, balance sheets, profit and loss statements relating to a period of at least two years to get a fair understanding of how the business has performed and to understand the authenticity of the title of the asset that has been given as collateral.
  • The interest rates generally range from 7% to 15% for an Asset Based Lending financing option and it can largely vary depending upon the value and the liquidity of the asset that is used as collateral.
  • In most cases, lenders would like to schedule a site visit to check for the condition of the property or the set of assets that have been provided as collateral to check for quality and to further determine the fair value of such property or assets put together.

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