Minute Mastery Series: Back of the Napkin Metrics

Video Transcription

Good morning everyone,

I'm Adam Hodge from Holland & Hodge Capital Partners and today in Minute Mastery Series we're going to go over key metrics that we look for in underwriting any deal that we see.So typically I'm asked from borrowers and brokers alike what is it that you look for when looking at a deal? Do you care about my credit score? Do you care about who I am as a borrower? My ability to pay you back from my business or cash flows? Is it more based on the asset? etc. What is it you actually look for when underwriting a deal? So I am going to try to do this in the next five minutes and we'll look through the key metrics and data points that we look at in any deal we handle.

The first key metric we look at is asset class or property type. Right, so some lenders will specialize in one particular asset class. The main food groups, as they are affectionately known, are:

  • Office
  • Retail
  • Mixed Use
  • Light Industrial
  • Multi-family

So, what type of asset is it? And then we want to know the location of it. Have we lent in that area? Are we familiar with that local market and are we comfortable with it?

Some of the data points that we'll look at for a particular location in this space are about trying to understand the demographics and what's happening in the market. We're going to look at the following here: So, number one let's say job growth. Right, is this a desirable city? Are people moving into the city? Are we seeing that overall population is growing? Are we seeing a general market appreciation? And so one of the good ways, one of the easiest ways to do this is to look at the residential and both the commercial perspective as well, but understanding what's happening. Are prices going up? Are we seeing appreciation in rent, both in the commercial and residential space? So try to get a feel for the asset class and where it's located and see if we're popular.

So from there I want to see the financials of the asset. So, what's happening right now and what's the strategy here? So is this a value added play where we're buying a distressed property, do some value-added improvements, so let's say permanent financing and just improve the property to where it becomes bankable by a conventional loan? So the best way to do that is to understand what's happening with the property. So we look at financials and particularly one of the easiest things or the first thing I ask for is how much is the building throwing off from an NOI perspective? What's the current NOI? And then I want to see based on looking at all their proformas and see what the break down is of the project and how much they project that's going to improve the overall value of the asset and the overall cashflows of the asset. Then I also want to understand whether it's an acquisition or whether let's say they already own it and they're looking for improvements on the property and how much equity do they have in the financing. So you know, is it a property where maybe it's worth five million but they have an existing three million dollars worth of debt? Or is there a lot of equity? Is this something where let's say they have 50% equity? For argument's sake let's say it's a 10 million dollar property first-lien for maybe 6 million. So you have a nice cushion there in the event that something goes wrong. So that's particularly important. As a lender we always want to know because most loans we do are non-recourse, right? So when I say non-recourse I mean the only recourse or path to repayment is through the asset. So that's something that's particularly important to pay attention to particularly if you are doing let's say a second lien position or you're doing mezzanine financing. And so as you go up the capital stack and get a little riskier in your loan, you want to make sure even more so there's definitely equity if you're the first lender.

So next we want to look at the exit strategy. So what is the term or duration of this note or this loan and how are we going to get out? Is that going to come through a refinance and get taken out by conventional financing through a bank or is it going to come from a sale of the building?

And then after I've gotten comfortable with the asset, I understand my exit, then I want to look at the borrower. So this is important even as a non-recourse lender because you want to know who it is you're dealing with and you want to make sure you're dealing with an experienced borrower. So the best way to do that is to look at their track record or their resume, right? We refer to that as the deal-sheet. So we'll definitely want to review the borrower's experience and see that they have a track record or proven record of working with this type of asset class in this particular market. Are they local to the market as well? That's really important. We want to work specifically with borrowers or sponsors that are in that market and know it well and have a proven track record.

So this is all very high level, but these are the basic back-of-the-napkin key metrics we look for when we work with any borrower.


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