Understanding Commercial Real Estate
Mortgage Investing

At AVANA, we believe institutional and accredited investors should have the ability to invest in commercial real estate properties in the United States. With this in mind, our goal is to provide a simple way to invest in mortgages and to supply our investors a predictable fixed income every month. AVANA invests in commercial mortgages for owner-occupied properties that are purchased by small and medium-sized businesses, so we look for entrepreneurs that want to own their own real estate and help fulfill their financial needs for the betterment of the business owners, investors, and communities all over America.

AVANA conducts exhaustive due diligence, credit underwriting, and risk mitigation on all financing requests. However, we believe that everyone should have a clear understanding of all the factors involved in investing in commercial real estate mortgages before committing, which is why we have put together this guide to increase your familiarity with the process.

Become Familiar with the Five Cs of Lending
AVANA assesses each request for financing based upon the traditional “5 Cs” of lending. Each “C” is evaluated, and extensive amount of work is done on each borrower or file before our investment committee approves the request.

The first factor involved in determining whether an individual will make an ideal borrower is his character. Because most small businesses do not have an established track record in their own right to provide credibility, we look into the history of the business owner to determine stability and ability to make good on the loan. Factors that are commonly evaluated include things like personal credit history, personal financial strength, relevant experience, and track record in the business and industry. An individual’s credit report plays a key role in this as it provides an in-depth look into the individual’s financial history and how he has handled debts and recurring payments in the past. Each reporting agency, or Credit Bureau, will provide a slightly different overall rating, which may be called a credit score or FICO score (named after the software developed by the Fair Isaac Corporation that many reporting agencies use). However, they all signify the same thing. On a scale of 300 to 850, those who manage their debts well have higher numerical scores and those with troubled financial histories have lower scores. Lenders will all have a different minimum FICO score threshold for borrowers, and it may also vary from one loan package to another.

AVANA Capital favors small-business owners who have invested in their own companies. By measuring personal capital, we can assesses the entrepreneur’s ability to repay the loan in the event the business does not meet its financial goals. It may also be referred to as “net worth,” which is an individual’s total assets minus his liabilities. Assets can take the form of an initial cash infusion, retained earnings, a car, real estate, cash, investments, savings, or other resources that the business owner may be able to draw upon if necessary to repay the loan.

Of equal importance is a borrower’s “capacity” to repay a loan. AVANA will examine all of an individual’s personal and company debts and expenses and will then compare them to cash flow. When the ratio of debt to income is smaller, it signals to us that the borrower will have the ability or capacity to make payments. We will look at a company’s historical cash flow to help estimate what it will generate in the future as well as personal information, such as past income, type of income, and employment history.

There are two main types of debt: secured and unsecured. With unsecured debts, the lender relies solely on the borrower’s promise to repay the loan. This is common with smaller debts, such as when a credit card is issued to an individual who has a good credit history. Most other types of debt, such as auto loans and home equity loans, are secured by some form of collateral. This means that the borrower promises to relinquish ownership of something of value, be it the vehicle or home in the aforementioned instances, if he’s unable to pay on his debt. Because the value of collateral may change over time, perhaps through depreciation of aging technology and equipment or as a result of a fluctuating market such as real estate, AVANA lends based on a borrower’s cash flow rather than collateral. The collateral is only used as secondary source of repayment of a loan for Note A and Note B investors. In other words, liquidating a borrower’s assets is an absolute last line of defense and is only utilized when the intended method of payment has failed. Sometimes, it’s necessary for another party to guarantee repayment of the loan as well. This is much like having someone co-sign on an auto or home loan.

Arguably, the most subjective criteria used in determining whether a loan will be issued are the market and economic conditions. AVANA evaluates how the borrower intends to use the funds as well as how external events may influence his ability to repay the loan. For instance, companies that rely heavily on the transportation of goods and people will have a surge in expenses if the cost of oil spikes quickly. Equally, the competitive environment, and how the business in question performs compared to its competitors, will be analyzed as well. This way, we can determine how the business will be impacted if a competitor moves in or what might happen if a leading source of consumers leaves the area, finds another supplier, or cannot afford to make purchases and payments.

Understanding Commercial Mortgage Structure

investment-structure

Commercial mortgages can be broken into two pieces, each with a different level of return and risk for investors, though the real estate security is the same. The first lien, which is generally documented as “Promissory Note A,” is paid first if assets must be liquidated in order to repay the loan, and it usually has a lower loan to value at the time the loan is issued. This means that if real estate property value declines, it’s least likely to experience a principal loss.

The second lien, which is generally documented as “Promissory Note B,” is subordinate to Note A, which means investors are paid second if assets must be liquidated to pay off the balance, and the loan to value is also generally higher. Therefore, if the balance due cannot be paid in full by liquidating assets, investors of Note A are paid first, and investors of Note B, who are paid afterwards, will suffer the principal loss.

Understanding Commercial Mortgage
Loan to Value Risk

SBA 504 Loans

understanding-sba504loans

  • At liquidation, if Property Value Declines > 20% then Note B investors will incur principal losses.

Construction Loans

understanding-construction-loans

  • Note A & B investors are at risk during construction.
    At liquidation, Note B investors’ principal balance is at risk if property value declines > 15%.

Bridge Loans

understanding-bridge-loans

  • At liquidation, if property value declines > 25% then Note B investors will incur principal losses.

Loan to Value (LTV) is a term that is very common in commercial real estate lending. It is simply the amount of commercial real estate property that is owned outright compared to the amount that is secured against a mortgage. To break it down with an example:

  • A property valued at $1,000,000 is obtained, and the borrower either has $200,000 equity or makes a down payment of $200,000. Because $200,000 is 20% of $1,000,000, the equity is considered to be 20% and the LTV is the remaining 80%.
  • The remaining amount owed (80% in this case) is secured by a mortgage, which may be divided into portions for both Note A and Note B investors. Generally, Note A investors will provide up to 50% LTV, while Note B investors will take anywhere from 51% to 90% LTV.
  • The Note A investors are in a very secure position because they will be paid first if assets ever need to be liquidated, so their expected return is lower. Note B investors are accepting the greatest risk due to the potential loss of property value coupled with receiving payment from the sale of assets after Note A investors. However, in exchange for accepting the higher risk, Note B investors can also expect higher returns for their investments.

Understanding Commercial Mortgage Maturity
(Time Horizon) Risk

Short Term

ST1
Monthly Payout
3 Month Term

3%

Annualized Rate
Select
ST2
Monthly Payout
24 Month Term

6%

Annualized Rate
Select

Long Term

LT1
Monthly Payout
3 Year Term

5%

Annualized Rate
Select
LT2
Monthly Payout
5 Year Term

9%

Annualized Rate
Select
understanding-sba504loans

Note A and Note B investors are also subject to risk that increases with loans that have longer maturities. In our history of completing $850MM+ loans, we have found that owner-occupied mortgages are subject to varying amounts of stress due to macro-economic factors, personal factors, legal changes, competitive threats both globally and domestically, management and personnel changes, and, finally, environmental factors. All of these play a distinct role and affect the small business borrower over time. AVANA’s rigorous due diligence, site inspection, and underwriting process allow us to evaluate commercial mortgage requests and lend only to those we feel will endure and perform as viable investments. Note A and Note B investors may invest in both short-term (12 months or less) and long-term (60 months) mortgages to provide predictable short-term and long-term earnings.

Understanding Default Rate

Note A and Note B investors carry the risk of loss in the event of default. The risk of loss is dependent on several factors:

  • The loan file where the 5 Cs are thoroughly assessed
  • The position within the mortgage capital structure (as a Note A mortgage or Note B mortgage)
  • The total loan to value based on the sum of Note A and Note B
  • The maturity of the mortgages

Due to our experience, we have extensive information on defaults by industry and by the types of properties in our portfolio. AVANA’s loan losses have been less than 1% of the total loans in our portfolio.

AVANA loans are documented at Note A and Note B promissory notes. When a borrower takes on a loan with AVANA, there are a list of conditions within the loan agreement that the borrower is expected to comply with. There are two types of defaults: payment default and technical default.

A payment default occurs when the borrower does not make timely payments of principal and interest on their mortgage. This means that Note A and Note B investors are not receiving their interest and principal payments on the mortgage they invested in with AVANA.

A technical default occurs when one of the conditions of the loan agreement has not been met or is being violated. For example, a technical default occurs if a borrower who initially agreed to provide quarterly financial statements in the loan agreement by a certain date fails to do so in a timely manner.

Once a default is declared, the loan is due and payable by the borrower. At this stage, the borrower is given a short window to cure the default and pay all default interest charges and fees incurred. If the borrower fails to cure the default, the lender will proceed with foreclosure and sheriff sale of the property. If, at the time of sheriff sale or auction, the purchasing offer is below the current value of Note A and Note B principal mortgage balance, then Note B investors will incur the loss in principal first before Note A investors are affected.

Decide How Much You Would Like To Invest

Short Term

ST1
Monthly Product
3 Month Term
Note A

3%

Annualized Rate

ST2
Monthly Product
24 Month Term
Note A & B

6%

Annualized Rate

Please insert amount above $100,000

Long Term

LT1
Monthly Product
3 Year Term
Note A

5%

Annualized Rate

LT2
Monthly Product
5 Year Term
Note A & B

9%

Annualized Rate

Please insert amount above $250,000

Portfolio Results

By Risk Profile

BY TIME HORIZON

 
Short Term
Short Term
Long Term
Long Term

By investment product

Short Term

ST1

$0.00

Monthly Income

ST2

$0.00

Monthly Income

Long Term

LT1

$0.00

Monthly Income

LT2

$0.00

Monthly Income

Investing In AVANA’s Mortgage Fund

All accredited investors should understand the risk associated with their investment. If you are an investor considering AVANA’s mortgage fund, then you should know exactly what you are investing in.

You should confirm:

  • Is your investment in the notes secured by real property?
  • What happens in the event of a default?
  • How long is your money tied up in these notes?
  • What is the track record of AVANA when it comes to commercial real estate lending?

Once you have read the private offering document then you can make an informed decision.

Build a portfolio of fixed income
earning secured by real estate

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