Income-Producing Properties
The term “income-producing” specifically refers to the presence of
a lease. In other words, there is a landlord-and-tenant relationship
in which the owner of the property (the landlord) leases the property
to a tenant. The phrase “income-producing,” from the perspective
of a lender, suggests that the cash flow used to pay back the loan will
be derived from monthly rent paid by the tenant to the landlord. The
landlord, in turn, takes the money that he or she receives from the
tenant and uses it to pay back the loan.
It is important to emphasize that the owner of the property (the
landlord) owns the property for no reason other than to make money
by leasing the property to business owners who are interested in only
renting and not owning. Notice the mutually exclusive benefit
between landlord and tenant. Landlords don’t want to own and operate
a business, and business owners (tenants) don’t want to own and
take care of a building. The landlord’s expertise is in owning and
operating commercial real estate, not the businesses that occupy
their buildings. Likewise, tenants can focus on running their business
without the worry of maintaining and operating a building.
Commercial real estate lenders, like landlords, are experts in
understanding the commercial real estate market and thus are willing
to loan money to a landlord. What commercial real estate lenders
don’t understand and prefer not to loan money for are the very businesses
that occupy the buildings. Why? The reason is that business
cash flow is a hundred times more difficult to understand. The practice
of lending to businesses is an entirely different industry and
often left to bankers who specialize in commercial and industrial
loans. Commercial real estate, on the other hand, in the eyes of the
commercial real estate lender, is a commodity that is easier to analyze
and much more predictable.
Commercial properties that are designed and built specifically
to be occupied by businesses that are unrelated to the landlord
are referred to as “investment properties.” Landlords buy incomeproducing
properties as an investment because of the anticipated
positive cash flows and capital appreciation. These positive cash
flows are supposed to represent both a return of capital and a return
on capital to the landlord. It is for this somewhat predictable cash
flow that lenders desire to loan money to landlords. Commercial real
estate lenders that try to loan money to owner-occupied commercial
properties must be able to understand the business and what it is
that the business does to generate revenue to ensure that the loan
can be repaid, which is very difficult. Unlike the income-producing
property, the owner-occupied property has as its only source of cash
flow the profit of the business, not the rent. If the lender can’t understand
the business, then it is less likely to loan money for the building.
There are lenders that lend to these types of commercial properties,
but not nearly as many as the number of lenders that desire to
lend on income-producing properties.