Due Diligence Needed For Refinancing Real Estate
There are a number of reasons to delve into the refinancing process for commercial real estate property. It can increase cash flow, as there may be less money outgoing each month, and it can also help startups obtain a better cash on cash return, the ratio of pre-tax cash flow compared to the amount invested and shown as a percentage.
Refinancing can also allow owners to use the excess cash to buy other investments or to perform repairs or renovations. These, in turn, can allow them to raise the rents and boost their revenue. As a result, this is a proven approach that many commercial property owners have taken.
It’s important that we define due diligence and this simply refers to the process of investigating or conducting an audit to confirm financials and legal documentation. It is the reasonable amount of care a financial institution needs to take prior to entering into an agreement with legal or financial ramifications, and the particulars will vary, depending in the type of property and the amount being refinanced.
Examples Of Due Diligence
Many details regarding the borrower will need to be examined, such as whether they are a partnership, an LLC, a trust, or a single individual. Also important is whether there are any trustees or beneficiaries and if any partners are limited. In addition, there may managers, officers, or people in the role of member or director. These various parties need to be identified and included and whatever arrangements are created.
In the event that there is a trust, the borrower will need to produce copies of their trust agreement, or if there is a partnership, the paperwork undergirding that agreement will be needed. Also vital is to have information regarding the governing bylaws that exist for each layer of the structure in question.
The lender will need to run the appropriate credit checks, and they will need to determine whether there are any pending judgments or ongoing litigation. Also vital is to know whether or not there have been bankruptcy filings and tax lien issues.
The borrower will need to demonstrate their creditworthiness as pertains to the refinance request, and it must be shown that the capital needed to supply the lender with monthly payments is available. Therefore, the borrower’s financial obligations to other institutions will need to be thoroughly examined.
It will be necessary to present real estate collateral and to state the intended use of this, including specifics pertaining to any interest that is collected from the property. Revenues that do not yet exist can also be considered.
Any restrictions to using the property in its intended fashion must be disclosed, and these can be physical as well as legal. Its estimated value must be calculated, and encroachments and any environmental conditions that would affect its utilization must be explored. Also of great importance are leases, their terms and whether this is sufficient to surmount the debt service.
If proposed improvements are slated to increase the value of the property, its approximate worth after the work has been done must be estimated. The construction budget must be defined, and any contracts with engineers, architects, or contractors must be discussed. It needs to be determined how the loan will be disbursed, whether that is to the building company through escrow or directly to the contractor.
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