    
Financing Tips...
We realize you may be a very sophisticated commercial property investor. However, we have provided some basic information that might assist you. As with any investment you should consult with your attorney, CPA and/or financial advisor before making any investment. You as an investor must perform all necessary due diligence when determining if an investment is right for you. The enclosed content is for informational purposes only and should NOT be considered as legal, tax or financial advice.
Common Document Types in Small Commercial Lending
Commercial vs. Investment property:
An investment property is still under residential lending guidelines for up to four residential units (a 4-plex). A multi-family unit building with five or more units is considered a commercial loan and falls under commercial lending guidelines. With one exception the State of New Jersey considers up to six units a residential loan. We offer assistance with BOTH types of loans! Of course retail, office, warehouse, industrial types of properties are clearly commercial.
"Commercial Property Loans vs. Small Business Loans" We offer financing for commercial property and NOT small business loans. We offer mortgages based upon the value of the property and NOT based upon the value of a business. All commercial property loans will value the property LESS the value of "F,F & E's" (furniture, fixtures & equipment). While you may obtain financing for the building with a commercial loan, financing of the business itself will require a different type of loan. However, owner occupied properties can use the cash flow of a business to qualify for certain loan programs.
Hard Money Loans
A hard money loan is a loan made based SOLELY on the value of a property. Credit scores and income will not be the deciding factors as these types of loans are an equity-based decision. In fact, you can obtain a Hard Money Loan even if you are in a "notice of default" on a property and your credit scores are below 500. Hard Money loans are faster than other loan types and are typically used for short term financing, as the interest rates are considerably higher than conventional loan programs. Hard Money loans can be made on residential, commercial and even land. Sometimes Hard Money Loans are used when a property needs to be secured very quickly, with conventional funding to follow. Sometimes a business needs a short-term loan and is willing to pay a higher interest rate to access fast cash flow, based upon the equity of a property. Another common term for a Hard Money Loan is a "Bridge Loan".
Bridge Loans
A bridge loan on commercial property is a short term loan, typically for 1-3 years and then comes due or "ballooons". Commercial property bridge loan rates are typically 7-8% interest only and HAVE NO PREPAYMENT PENALTY, you will however be required to pay points upon the closing of the loan. The amount of points due varies based upon the size of the loan, project type and are determined on an individual case basis.. To qualify for a bridge loan the project must have a clear "exit strategy". This type of loan is typically used for "flipping" a property, condo-conversions, rehabilitation or other need to "bridge" the gap to permanent loans or sale of the property. Bridge loans are available to 35 million, nationwide.
Common Document Types in Small Commercial Lending
True No Doc
The lender is looking primarily at the financials of the property itself for loan approval. The borrowers FICO (credit score) will be considered. Typically a minimum middle FICO must be at least 620 to qualify. The lender will NOT request proof of income or assets, nor will they request that the borrower "state" income or assets. The lender will rely primarily on the financial strength of the property. This loan type is typically for up to 75% loan to value and allows the seller or other party to "carry back" an additional 5% in the form of a second mortgage. CLTV (combined loan to value) of 80% is typically the maximum for this type of loan. Interest rates are very aggressive and are almost always "at or near" full doc pricing.
Stated Income / Stated asset
Again the lender is looking primarily at the financials of the property itself for loan approval. The borrowers FICO (credit score) will be considered. Typically a minimum middle FICO must be at least 580 to qualify. The lender will NOT request proof of income or assets, HOWEVER they will require that the borrower "state" income or assets. The lender will rely primarily on the financial strength of the property. This loan type is typically for up to 80% loan to value and allows the seller or other party to "carry back" an additional 10% in the form of a second mortgage. CLTV (combined loan to value) of 90% is typically the maximum for this type of loan.
Full Doc A-Paper
The lender is looking primarily at the financials of the property itself for loan approval, however the borrowers personal income and assets are also considered. The borrowers FICO (credit score) will be considered. Typically a minimum middle FICO must be at least 620 to qualify. The lender will require proof of income and assets. The lender will rely on the financial strength of the property AND the borrower. This loan type is typically for up to 80% loan to value. CLTV (combined loan to value) of 90% is typically the maximum for this type of loan, however rates are considerably higher to get 90% loan to value. In addition, 90% loan to value loans are for a maximum of $1,000,000 loan amount. (THIS LOAN TYPE OFFERS THE ABSOLUTE LOWEST RATES & BEST TERMS AS IT HAS THE LOWEST LENDER RISK)
Full Doc ALT-A-Paper
The same as "Full-Doc A-Paper" however a lower minimum middle FICO must be at least 580 to qualify. The lender will require proof of income and assets. The lender will rely on the financial strength of the property AND the borrower. This loan type is typically for up to 80% loan to value and allows the seller or other party to "carry back" an additional 10% in the form of a second mortgage. CLTV (combined loan to value) of 90% is typically the maximum for this type of loan.
Direct Capitalization Rate (DCR or CAP)
What is a CAP Rate?
Direct Capitalization (CAP) is a method used to covert a property's annual income, into an estimate of the property's value.
The Direct Capitalization Rate (CAP Rate) is defined as follows:
Value = Net Operating Income__
Overall Capitalization Rate
For Example:
V = $3,913,043
NOI = 450,000
CAP Rate = .115
$3,913,043 = $450,000
=.115
The CAP Rate in the above example is 11.5% (.115 X 100 = 11.5)
Other derivatives of the formula are as follows:
Net Operating Income = Overall Capitalization Rate X Value
Overall Capitalization Rate = Net Operating Income Value
The formula for calculating Net Operating Income is as follows:
Potential gross income (all figures are on a annual basis)
Scheduled rent $xxxx
Other income $xxxx
Total potential gross income $xxxx
Vacancy and collection loss -xxx
Effective gross income $xxxx
Operating expenses
Fixed $xx
Variable $xx
Replacement allowance $xx
Total operating expenses -$xxxx
NET OPERATING INCOME $XXXX
Commercial Underwriting Basics
Commercial loans are generally underwritten on a case-by-case basis. Each loan application is unique and evaluated on its own merits, but there are a few common criteria lenders look for in commercial loan packages.
Financial Analysis
A key component in making an underwriting evaluation is the debt coverage ratio (DCR). The DCR is defined as the monthly debt compared to the net monthly income of the investment property in question. Using a DCR of 1:1.10 a lender is saying that they are looking for a $1.10 in net income for each $1.00 mortgage payment. Typically they will determine the DCR ratio based on monthly figures, the monthly mortgage payment compared to the monthly net income. The higher the DCR ratio is the more conservative the lender. Most lenders will never go below a 1:1 ratio (a dollar of debt payment per dollar of income generated). Anything less then a 1:1 ratio will result in a negative cash flow situation raising the risk of the loan for the lender. DCR's are set by property type and what a lender perceives the risk to be. Today, apartment properties are considered to be the least risky category of investment lending. As such, lenders are more inclined to use smaller DCR's when evaluating a loan request. Make sure that you are familiar with a lender's DCR policy prior to spending money on an application. Ask them to give you a preliminary review of the investment property that you want to purchase. Information is free, mistakes are not.
Loan to Value (LTV)
Unlike residential lending, commercial investment properties are viewed more conservatively. Most lenders will require a minimum of 20% of the purchase price to be paid by the buyer (we do have 10% down programs however). The remaining 80% can be in the form of a mortgage provided by either a bank or mortgage company. Some commercial mortgage lenders will require more than 20% contribution towards the purchase from the buyer. What a bank/lender will do is subject to their appetite and the quality of the buyer and the property. Loan to value is the percentage calculation of the loan amount divided by purchase price. If you know what a lender's LTV requirements are, you can also calculate the loan amount by multiplying the purchase price by the LTV percentage. Keep in mind that the purchase price must also be supported by an appraisal. In the event that the appraisal shows a value less then the purchase price, the lender will use the lower of the two numbers to determine the loan that will be made.
Credit Worthiness
For businesses less than three years old, personal credit of principals will typically be evaluated. This may hold true for longer periods of time for tightly held companies. For corporations, business performance and credit ratings will be evaluated with a proven track record. Individuals often qualify based solely upon their FICO / Credit Scores.
Property Analysis
Fair Market Value and Fair Market Rent will be analyzed. Special use property may require additional underwriting. Age, appearance, local market, location, and accessibility are some other factors considered. Different property types are treated differently when it comes to allowable Loan-to-Value ratios.
Commercial Lending Ratios
Most of real estate lending can be boiled down to the results of three ratios:
· Loan-To-Value Ratio
· Debt Ratio
· Debt Service Coverage Ratio (DSCR)
The bulk of the energy spent "processing" a loan is merely an attempt to verify the numbers that go into the numerator and denominator of the above 3 ratios.
The Loan-To-Value Ratio (LTVR) equals the total loan balances (1st mtg+2nd mtg+3rd mtg) divided up the fair market value (as determined by appraisal). Loan-To-Value Ratios seldom exceed 80% because the lender will always want some extra protection against default.
The second ratio that lenders use when underwriting a loan is the Debt Ratio. The Debt Ratio compares the amount of bills that the borrower must pay each month to the amount of monthly income he or she earns. More precisely, the Debt Ratio equals the monthly debt obligations divided up the monthly income. Obviously someone who's Debt Ratio is 150% is in trouble. A Debt Ratio of 150% would mean that a borrower's obligations are one and a half times his income. Debt Ratios seldom are allowed to exceed 40% in practice for a "full doc" Loan. No Doc & Stated / Stated doc types do not verify this ratio.
The final ratio used in lending is the Debt Service Coverage Ratio (DSCR). The Debt Service Coverage Ratio is a sophisticated ratio commonly used for large loans on income producing properties. Debt Service Coverage Ratio equals net operating income divided by debt service. Net operating income is the income from a rental property after deducting for real estate taxes, fire insurance, repairs and all other operating expenses; and Debt Service is the mortgage payment on the property. Most lenders insist that this ratio exceed 1.0. A debt service coverage ratio of less than 1.0 would mean that the property did not produce enough net rental income for the owner to make the mortgage payments without supplementing the property from his personal budget. However, loan programs DO EXIST that allow the borrower to supplement the debt service of a property with personal income.
Commercial Loan To Value Ratios
The loan-to-value (LTV) ratio is probably the most important of the 3 underwriting ratios. The loan-to-value ratio is defined as:
LTV Ratio = Total Loan Balances (1st mtg+2nd mtg +3rd mtg) / Fair Market Value of the Property
First let's look at the numerator. If the borrower is only applying for a first mortgage and there will be no other loans on the property, then the beginning balance of the new loan requested should be inserted in the numerator.
However, if the borrower is applying for a second mortgage, then the "underwriter" (the person who determines whether or not the loan qualifies) should insert the sum of the first and second mortgages in the numerator. Similarly, if the borrower is applying for a third mortgage, then the underwriter should insert the sum of the first, second and third mortgages into the numerator.
When the borrower is applying for a second or third mortgage, the loan-to-value ratio is often known as the combined loan-to-value ratio (CLTV ratio).
Now let's look at the denominator. Generally the fair market value of a property is determined by an appraisal. There is one important exception, however. When the proceeds of a mortgage loan are used to buy the same property that is securing the loan, then that mortgage is known as a "purchase money loan." If the appraisal comes in lower than the purchase price in a "purchase money" transaction, then the lender will use the LOWER of the purchase price or appraisal.
Mortgage brokers are often asked by real estate agents and buyers to base their loan on the appraised value rather than the purchase price. Their claim is that they have negotiated a super deal and that the property is worth much more than what they are paying for it. This may be so (although generally untrue), but lenders always base their maximum loan on the lower of purchase price or appraisal. The lender's argument is that an appraisal is really no more than an estimate of fair market value, no matter how competent or conscientious the appraiser may be. The only true indicator of value is the marketplace in which "a willing buyer and a willing seller, each in full knowledge of the salient facts, and neither under undue pressure, agree upon terms." If the property sells for "X," then it is probably only worth "X".
Debt Service Coverage ratio (DSCR)
The most important ratio to understand when making income property loans is the debt service coverage ratio. It equals Net Operating Income (NOI) divided by Total Debt Service. To understand the ratio it is first necessary to understand the numerator and the denominator. Let's take a look at net operating income (NOI) first.
Net operating income is the income from a rental property left over after paying all of the operating expenses:
Gross Scheduled Rent $100,000
Less 5% Vacancy & Collection Loss $5,000
________
Effective Gross Income: $95,000
Less Operating Expenses
Real Estate Taxes
Insurance
Repairs & Maintenance
Utilities
Management
Reserves for Replacement
Total Operating Expenses: $30,000
Net Operating Income (NOI) $65,000
Please note that lenders always insist on some sort of vacancy factor regardless of the actual vacancy rate in an area to cover collection loss. In addition lenders always insist on using a management factor of 3-6% of effective gross income, even if the property is owner-managed. Their logic is that they would have to pay for management if they took back the property. Finally, NOTE THAT WE HAVE NOT INCLUDED LOAN PAYMENTS AS AN OPERATING EXPENSE. Next let's look at the denominator, Total Debt Service. This includes the principal and interest payments of all loans on the property, not just the first mortgage. NOTE THAT WE HAVE NOT INCLUDED TAXES AND INSURANCE. They were already accounted for above when we arrived at net operating income (NOI).
To calculate the debt service coverage ratio, simply divide the net operating income (NOI) by the mortgage payment(s). For the sake of simplicity, let us assume that there is only one mortgage on the property:
$500,000 First Mortgage
11% Interest, 30 years amortized
Annual Payment (Debt Service) = $57,139
Then:
DSCR = Net Operating Income (NOI) = $65,000
Total Debt Service $57,139
DSCR = 1.14
Obviously the higher the DSCR, the more net operating income is available to service the debt. From a lender's viewpoint it should be clear that they want as high a DSCR as possible.
The borrower, on the other hand, wants as large a loan as possible. The larger the loan, the higher the debt service (mortgage payments). If the net operating income stays the same, and the loan size and therefore the debt service increases, then the lower the DSCR will be.
Life insurance companies are very conservative and generally require a 1.25 or 1.35 DSCR. This means that their loan-to-value ratios are low. Savings and loans (S&L's) generally only require a 1.20 DSCR, and sometimes will accept a DSCR as low as 1.10.
A DSCR of 1.0 is called a break-even cash flow. That is because the net operating income (NOI) is just enough to cover the mortgage payments (debt service).
A DSCR of less than 1.0 would be a situation where there would actually be a negative cash flow. A DSCR of say .95 would mean that there is only enough net operating income (NOI) to cover 95% of the mortgage payment. This would mean that the borrower would have to come up with cash out of his personal budget every month to keep the project afloat.
Generally lenders frown on a negative cash flow. Some lenders will allow a negative cash flow if the loan-to-value ratio is less than around 65%, the borrower has strong outside income such as an electronic engineer, and the size of the negative is small. Lenders rarely allow negative cash flows on loans over $200,000.
What is a Gross Rent Multiplier ?
A Gross Rent Multiplier (GRM) is a capitalization method for calculating the rough value of a property based on an income approach method.
The Gross Rent Multiplier (GRM) formula for value is as follows:
Value = Annual Gross Income (Rents) (AGI) X Gross Rent Multiplier (GRM)
For Example:
AGR = $500,000
GRM = 8
Potential Property Value = AGI X GRM = $400,000
Obviously, the value of a property is a direct correlation to the GRM. Therefore, using an accurate value for the GRM is critical for determining an accurate property value. The GRM variable can be found from a local appraiser who will calculate GRM's from comparable closed sales in the immediate area and then average them to one number. They take the recent sales prices of the comparable properties in the area and divide them by the respective Gross Incomes. The immediate area used for comparables surrounding most subject properties will fall into a narrow GRM gap. However, GRM's can vary considerably depending on the location. For an example; San Francisco, New York, and Miami will have a much higher GRM than a small town in the Midwest.
Disclaimer
The information provided in this website is deemed reliable, however it is not guaranteed. The accuracy of all information regardless of source, including but not limited to square footages and lot sizes, is deemed reliable but is not guaranteed and should be independently verified through personal inspection by and/or with the appropriate professionals.
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