Market Rents vs. What the Market Will Bear

Some of our clients have found that they have been able to secure leases from their commercial tenants at lease rates above prevailing market rents in their area.  While this additional cash flow benefits the owner over the course of the lease term, it can be a detriment when trying to obtain a commercial loan.   Most lenders will adjust the inflated lease rates back to market rents, thus discounting the property value and, consequently, reducing the amount they will lend against on the subject property.

To borrowers this may not seem like fair treatment for their ability to obtain higher cash flow per square foot than comparable properties.  However, from the perspective of the lender, if the borrower defaults on the loan and the lender has to foreclose on the property, at what lease rate will the lender be able to charge to replace the tenants that have either left the property or whose leases have expired and a renewal of the lease must be renegotiated.

So, do not be surprised if your lender adjusts your above market rents when you apply for a commercial loan.  If the loan amount ends up being lower than you anticipated you may want to cross-collateralize other properties with the subject property and/or seek a second loan behind the first to achieve the total funding you require for your project.