Beyond the Rate: How to Evaluate Lenders and Term Sheets Like a Pro

Most commercial real estate (CRE) sponsors obsess over one thing when choosing a lender: the interest rate.

A lower rate means higher returns – so why wouldn’t that be the primary focus?

Because debt is not a commodity.

Two lenders offering the same rate can structure vastly different deals, and the wrong lender can kill your deal faster than a market downturn. Loan covenants, default interest rates, lender flexibility, and term sheet transparency can make or break your project. Yet, many sponsors don’t recognize these risks until they’re trapped in a bad situation.

Let’s break down how to evaluate commercial real estate lenders, analyze term sheets like a pro, and negotiate financing that sets you up for success – not disaster.

The $2,500 Mistake That Cost $500,000

Consider this real-world scenario:

A sponsor secured a $4,000,000 bridge loan from a private lender. The terms seemed fair – nothing out of the ordinary.

Then, a $2,500 bounced check triggered a technical default.

The lender immediately enforced default interest at 24% per year. The borrower, convinced the lender was bluffing, refused to resolve the issue.

For six months, the battle dragged on.

By the time a resolution was forced, the loan balance had ballooned to $4,500,000, an additional $500,000 in default interest, legal fees, and penalties.

The irony? The lender likely would have let the missed payment go had it been resolved immediately.

The lesson is clear: Know your loan terms, understand your lender’s behavior, and never assume debt is just about the rate.

Not All Lenders Are the Same

Lenders might look similar on the surface – after all, they all provide financing using risk-based underwriting. But behind the scenes, they vary dramatically in how they operate.

• Some prioritize long-term relationships. Others are transactional and will cut you loose at the first sign of trouble.
• Some keep covenants reasonable. Others insert predatory clauses designed to force a re-trade.
• Some are transparent. Others leave key details vague, only to reveal them at closing.

Before you agree to a loan, understand the lender’s track record, flexibility, and appetite for your deal type.

Three Critical Questions to Ask About Your Lender

1. What happens when a deal runs into trouble?
   • Do they work with borrowers on modifications, or do they rush to default?
   • Have they shown flexibility in past workouts?
2. Are they truly committed to funding this loan?
   • Some lenders “shop” loans, making commitments they can’t fulfill.
   • Others intentionally re-trade terms just before closing.
3. How do they enforce loan covenants?
   • Do they give reasonable time to fix minor issues, or do they enforce penalties aggressively?
   • How high is their default interest rate?

A good lender is a strategic partner – not a ticking time bomb waiting to go off the moment your deal hits a bump.

How to Read a Term Sheet Like a Pro

Most sponsors treat a term sheet as a final contract. It’s not.

Think of it as a highlight reel – a preview that often leaves out key details that will surface in the final loan documents. If you don’t scrutinize it early, you may waste weeks negotiating a deal that was never viable in the first place.

The Three Biggest Traps in Term Sheets

1. Prepayment Penalties That Kill Your Options

1. • Yield maintenance and defeasance can lock you in – even if refinancing makes strategic sense.
   • Some lenders base penalties on total loan balance instead of remaining interest, making early payoff prohibitively expensive.
   • “Soft” prepay structures may seem flexible but often contain hidden step-downs or lender discretion clauses.

1. Covenant Traps That Can Force You into a Capital Crunch

1. • DSCR cash sweeps: If your coverage ratio dips below a threshold, the lender can seize excess cash flow, squeezing your operations.
   • Liquidity covenants: Some lenders require ongoing reserves, even after funding, forcing unexpected capital calls.
   • Refinance restrictions: Certain terms can prevent you from restructuring or taking on secondary financing, limiting your flexibility.

1. Hidden Default Clauses That Put You at Risk

1. • Technical defaults: A missed reporting deadline, an unapproved property manager, or an insignificant ownership change could trigger default – even if payments are current.
   • Springing recourse: Some loans start as non-recourse but become full recourse under certain conditions (e.g., a covenant breach).
   • Material adverse change (MAC) clauses: Vague language allows lenders to pull financing based on subjective assessments, creating uncertainty.

A strong sponsor doesn’t just scan a term sheet – they dissect it.

The Art of Negotiating a Stronger Deal

Many sponsors assume lender terms aren’t negotiable. This is a myth.

While banks and institutional lenders may have less flexibility, private lenders and debt funds negotiate constantly. But you need to know how to ask.

How to Strengthen Your Negotiating Position

Step 1: Create Competition

Never approach a single lender.

Secure multiple term sheets and use them as leverage. Lenders will sharpen their pencils when they know they’re competing for your business.

Aside from providing access to a wider range of lenders, a skilled financing intermediary creates a market for your deal. They will force lenders to compete on interest rates and loan terms, which more than makes up for the financing fees they charge.

Step 2: Push for Transparency

Lenders that hide key terms in final agreements often do so intentionally. Force clarity upfront.

Request a term sheet that includes:

• Default interest rates
• Prepayment flexibility
• Covenant requirements

If a lender resists transparency, that’s a red flag.

Step 3: Protect Your Exit

Most sponsors assume they can refinance whenever they want – but some lenders block early payoffs with yield maintenance penalties.

Negotiate:

• A clear path to refinancing
• Reasonable extension options
• Flexible prepayment terms

Regardless of your execution plan, it’s always wise to keep an eye on flexibility, leaving your options open. The last thing you want is to be locked into a loan agreement when the dream buyer comes out of the woodwork.

Step 4: Get Legal Backup

Your financing intermediary is an excellent advocate for getting the best rate and terms for your deal.

This is a team sport, though.

Your attorney should redline the term sheet before you sign anything. Many “standard” terms are actually highly negotiable – if you push back.

Lenders Can Make or Break Your Deal

A good lender doesn’t just offer a competitive rate – they provide a partnership that supports your success.

A bad lender? They can trap you in costly default interest, enforce rigid covenants, and kill your ability to exit.

Remember This!

• Debt is not a commodity: treat lenders like equity partners, not interchangeable vendors
• Analyze the term sheet carefully: small details can lead to massive headaches later
• Negotiate aggressively: use lender competition to secure better terms
• Understand the default process: one misstep can escalate costs exponentially

Smart sponsors don’t just chase the lowest rate. They choose lenders who align with their investment strategy, offer fair terms, and remain transparent throughout the process.

Want more high-level strategies on underwriting, structuring deals, and raising capital?

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