Property Condition as it Relates to Your Refinancing

By Hal Reinauer

The lending world has turned a more watchful eye to property condition and begun to take notice of reduced capital improvement programs. This attention has made it more difficult for those properties with some issues to find a reasonable lending solution, even with stable cash flows supporting the loan request. Appraisers and Engineers, like banks and lenders, have also felt the pressure and they have reacted with greater scrutiny and increased attention to the ongoing maintenance schedule and immediate repairs. To prevent this from affecting your refinance there are a few critical steps you can take to ensure your property receives the credit it is due.

  1. Housekeeping. First, ensure that the grounds of the property are clean and free of any refuse, graffiti and tenant property that have overflowed into the common areas. The property inspector will be adversely impacted by the minor details that are his first impression of the property exterior and grounds so make sure that any obvious exterior damage, paint peeling, torn screens, broken windows, misaligned or missing gutters, broken parking lights and any other repair item that can be taken care of at minimal cost is addressed promptly and prior to the site inspection. The cleanliness of the property is extremely important in how your property will be viewed by the engineer and the lender. Have the maintenance staff pay special attention to these needs and the long term benefit will pay off with increased occupancy and greater financing potential. The site inspection will concentrate on housekeeping, site issues, parking areas, building exteriors, roof, foundations, HVAC, plumbing, electrical, fire and life safety, dwelling units and common areas, so you as the owner/operator should as well.
  1. Anticipate. Second, identify your major capital needs before the engineer does. Engineers are looking for the building systems that need replacement now and throughout the loan term so identifying those yourself and having your own schedule prepared with cost assumptions will save you in the long run. A good replacement schedule is a detailed one; make sure you cover as many building systems as you can and make reasonable assumptions as to their useful life, replacement cost and quantity. Having the information on the age and type of the building systems is also very important; windows, roofs, HVAC systems, water heaters, kitchen appliances, counters, cabinets, vanities and flooring are typical line items included in the schedule. Also try and take an assessment of your annual plumbing and electrical expenses as these assumptions will assist your lender in differentiating between one time capital expenses and actual ongoing needs.

It’s also a good idea to acquire actual bids for projects you wish to complete in the near future as there can be a wide range of prices associated with even the most basic of repairs. Having a good bid in hand will prevent any discrepancy with what you believe a project to cost and the engineer has estimated.

  1. Awareness. Third, be aware of the big issues. Pay particular attention to any issue that could cause water infiltration, mold, electrical issues (low amperage, aluminum wiring, etc), plumbing systems (polybutylene piping, galvanized piping, etc) and any life safety issue (fire systems, hand rails, deck structures, tripping hazards etc). Being aware of the major issues at your property and having a preventative maintenance plan or explanation of corrective measures already taken will assist the lender in mitigating the risk and speed the process along.

Finally, understanding your replacement reserve schedule and escrow is essential. Once the engineer and lender have completed their site inspection they will prepare a list of immediate needs and ongoing replacement reserves. This is where the owner prepared budget and bids will play a great role in balancing the interests of all parties. The Fannie Mae guide, as well as the other GSE’s and lending institutions, includes certain parameters for the collection of ongoing replacement reserves based on a scale of the property’s condition.

  • Limited Reserves – The Property has been exceptionally well maintained such that a minimal reserve estimate is adequate to cover emergency repair issues if they arise during the Mortgage Loan term.
  • Moderate Reserves – The Property is in adequate condition for its age and construction type and will require only typical repairs/replacements during the Mortgage Loan term
  • Substantive Reserves – The Property exhibits characteristics or construction quality that make more substantial replacement reserves necessary in order to mitigate certain risks inherent in the physical asset.

Replacement reserves are an operating cost, so remember that these funds are yours to spend and utilize for the ongoing maintenance of the property. The lender holds these funds to protect their investment in the property only, and will take into consideration the effect on cash flow when sizing your facility. If your previous reserve escrow was $0 and now it’s $200/per unit per annum that does not mean your total operating costs have risen by $200 per unit, but that the allocation of funds previously included in line items such as repairs and maintenance, supplies, and contractors will now be captured in a lender established reserve and reduced from the proforma projections. The net effect on ongoing cash flow for properties that have been well maintained should be negligible if you work with your lender to ensure the accuracy of your operating statements and maintenance budget.

Finally, remember that the lender and your interests are the same; we both want to see the asset be a long term viable investment.