A real estate term sheet is a critical document in the lending stage of a real estate transaction. It indicates that the lender is willing to proceed with a loan -- but only if the borrower can commit to the conditions that are carefully detailed.
The term sheet is not a legal document nor is it a definitive agreement, as it doesn't indicate any commitment on the part of the lender. It's issued only after the lender's thorough analysis of the borrower and the proposed real estate transaction.
How is a term sheet used in commercial real estate?
When buyers wish to get loans for commercial properties, the term sheet details the financing terms that the bank or lending firm is willing to extend. While every real estate transaction is different, a term sheet at least starts out the same in regard to the type of information needed.
What is included on a commercial real estate term sheet?
Here's an overview of the sections that will likely be listed on a term sheet needed to proceed with a commercial real estate loan:
Borrower. In commercial real estate, this is likely an LLC, joint venture, company, or other legal business entity that wishes to buy the real property.
Purpose. This is especially important in the CRE world; when borrowers agree to use loans for a certain purpose, they must follow through on that purpose or risk losing the loan.
Amount. This refers to the loan amount, not the sale or purchase price of the commercial property. Particularly in large real estate transactions, there could be more than one lender financing the deal terms. This amount refers to the loan with this particular lender.
Interest rate. This is the rate offered by the lender, as well as whether it's a fixed or adjustable rate over the course of the loan.
Fees. This includes the loan origination fee and any other costs incurred.
Maturity. This defines the length of the loan, as well as any options for an extension.
Payment terms. This includes the loan payment structure; for example, the payment may only include the interest in each monthly payment with the principal payment due when the loan matures.
Amortization period. This may be defined together with the payment terms if they're different. For example, the payment term might be 10 years, but the amortization period is 20 years.
Collateral. This explains the collateral that will be used to secure the loan. This could include an asset list or rent and lease monies.
Guarantor(s). This includes the names of the individuals who will be held responsible, both individually and collectively, for the loan.
General performance covenants. This is the part that truly makes a term sheet different for every separate real estate deal. These may include stipulations made by the lender, such as the borrower must seek express permission by the lender before taking on any additional debt.
Items needed by the closing date. This is a somewhat long list of items that must be presented before or by the closing, including bank statements, tax returns, surveys, inspections, reports, and more.
What happens when the borrower has the term sheet?
Once the lender provides the borrower with the term sheet, any of these three scenarios can result:
- The borrower accepts the term sheet as written. It's signed and sent back to the lender, who starts the underwriting process. While it's rare for this to happen without some negotiation, it is possible.
- The borrower will negotiate some of the points outlined. If the lender agrees to the revised terms, a new term sheet will be submitted to the borrower. Once that new sheet is signed, the commercial real estate loan can go on to the underwriting process.
- The borrower rejects the terms, either unwilling or unable to negotiate. As the document is nonbinding, there are no fees or penalties for walking away from the deal.
If the term sheet is indeed signed, the underwriting process involves a detailed analysis of the commercial real estate transaction. If everything looks good and the lender agrees to take on the risk of the loan, it's now time for the lender's commitment. While this agreement is a similar document to the term sheet, it's different in that this is now an actual commitment to loan the money to the borrower. It also means that the lender and the borrower have entered into a binding contract. From this point on, if either party steps away from the deal, there will be legalities to deal with.
The bottom line
While negotiable to a certain point, the term sheet in a commercial real estate deal is a crucial document that can result in a binding contract between the lender and borrower. It's important to iron out the details in the term sheet so that neither the lender nor the borrower wastes any time on a real estate deal when there's little hope of securing the funding for it.