Commercial Lending Ratios
Most of real estate lending can be boiled down to the results of three ratios, which are described in this article.

Commercial Loan to Value Ratios
The loan-to-value (LTV) ratio is probably the most important of the 3 underwriting ratios.

Commercial Property Types
Listed in this article is a partial list of properties that require commercial financing.

Questions to Ask Yourself
This article poses several questions related to commercial financing.

Commercial Loan Checklist
This list will help you identify the types of information a banker will need to make an informed decision about your business.

Financing Options
Research credit lines and other financing approaches.

 

 
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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 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 whose 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.

The final ratio used in lending is the Debt Service Coverage Ratio (DSCR). The Debt Service Coverage Ratio is a sophisticated ratio only 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.

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Commercial LTV Ratio


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."

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Commercial Property Types


 Listed below is a partial list of properties that require commercial financing.
 
Type A Type B
  • Multi Family
  • Office
  • Warehouse
  • Commercial Condo Office
  • Auto
  • Convenience Store
  • Hotel
  • Day Care
  • Bed & Breakfast
  • Storage
Type C Type D
  • Mobile Home Parks
  • Funeral Homes
  • Rooming Houses
  • Marinas
  • Restaurants
Additional Property Types  
  • Commercial
  • Retail
  • Office Buildings
  • Mixed Use
  • Mini Storage
  • Gas Stations
  • Car Wash
  • Churches
  • Apartment
  • Land – Raw & Undeveloped
  • Adult Entertainment Clubs

 

 

 

 

 

 

 

 

 

 

Commercial Mortgage - Questions to Ask Yourself


Are you and your business credit worthy?
Your personal and business credit ratings will be analyzed.

What kind of money do you require?
Short, long, intermediate term money or equity capital.

How much money do you need?
Present exactly what you need and what it is for.

Do you have sufficient collateral?
Your collateral must equal the loan amount at a minimum.

What are the lender's rules?
Ask about loan-to-value and debt coverage ratios.

What kinds of limitations will be set by you?
Know your comfort level with rate, payment, and term.
 

 

 

 

 

 

 

 

 

 

 

 

Commercial Loan Checklist


The following list will help you identify the types of information a banker will need to make an informed decision about your business:
  • Three years income tax and financial statements
  • Year-to-date profit & loss and balance statement
  • Personal finance statements
  • Projected cash flow statements for next 12 months
  • Pro forma for next 12 months / length of loan
  • Federal and state tax information
  • Collateral sheet
  • Well written business plan

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Commercial Financing Options


Credit Lines
Under a credit line agreement, the lender supplies a business with funds intended to fill temporary shortages in cash that are brought about by timing differences between outlays and collections. Typically used to finance inventories, receivables, project or contract related work.

Short Term Loans
Short term loans are used for seasonal build-ups of inventory and receivables. Generally they are repaid in a lump sum at maturity, made on a secured basis and are for a term of a year of less.

Asset Based Loans
A lender advances funds based on a percentage of your current assets. The loan is used as source of funds for working capital needs. A lender typically takes a security position in the assets owned by the business.

Contract Financing
Funds are advanced to you as work is performed. Payments by the contracting party are generally made directly to the lender.

Factoring
Factors actually buy your receivables and rely on their own credit and collection expertise. Essentially, your customers become their customers. Factoring is used by firms who are unable to obtain bank financing. The cost of financing is usually higher than other forms of S-T financing.

Term Loans
Term loans are used to finance your permanent working capital, new equipment, buildings, expansion, refinancing, and acquisitions. Commercial banks are the major source of funding. The term of the loan is based on the useful life of the assets being financed or collectivized. Your projected profit and cash flow are two key factors lenders consider when making term loans.

Equipment and Real Estate Loans
Loans are fully secured by the equipment being purchased. Typically banks loan 60-80% of the value of the equipment and is repaid over the life of the equipment. Lenders make long term loans secured by commercial and industrial real estate. The loan is usually made up to 75% of the value of the real estate to be financed. Repayment terms range from 10 to 20 years. Lenders also make second mortgages on real estate. The amount of the second mortgage is based on the appraised market value and the amount of the first mortgage.

Leasing
Leasing can be accomplished through a bank, leasing or finance company. Your business will be subject to the same type of review as when seeking a loan, specifically cash flow of company, value of lease object and useful life. Lease terms range from 3 to 5 years. At the end of the lease, there are generally 3 options: purchase, renew and return.

3-15 YR Balloon Loans
Balloon loans offer interest rates that are fixed for a period of years. Typically these loans are pegged to a treasury index. Terms are for 3, 5,7,10 or 15 years. The amortization schedules are generally for 20 or 25 years. When a balloon loan matures at the end of the agreed term, the remaining principle balance outstanding is due at that time. The borrower can pay off the loan by either selling the property or refinancing. Investment property is typically owned for a previously defined period of time. Analyze your investment strategy before securing a balloon. Having to redo a loan is expensive.

Adjustable Rate Loans
An adjustable rate loan will typically fully amortize with no balloon features. These loans may or may not have adjustment caps. The rate is determined by an index plus a margin. The indices used are generally U.S. Treasury bond rates. Rates are adjusted at a certain point in time using either the current rate of the index in question or the average of the index for the prior year. In either event, the index used will correspond to the adjustment term. If the loan is a three year adjustable, then the index used should be the three year treasury index. Some adjustable rate loans are fixed for an initial period of years and then will adjust after that period. For example a 5/1 adjustable is fixed for the first five years and there after will adjust each year. The index used will be the one year treasury rate.

Please note that commercial lending is not standardized as it relates to programs and to guidelines. Banks must meet certain federal standards, but the index, margin, amortization, term and fees are components that are controlled by the investor based on their risk profit analysis. Remember that this mortgage will be the greatest expense your investment property will be responsible for. As such we recommend that you consult your real estate agent and your loan officer to assist in providing you with all the information needed to make a complete and accurate choice.

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