Most individuals have a general understanding of what it takes to qualify for a home loan, but few know what the basic requirements commercial lenders require for commercial real estate loans.
There are 5 main qualifying criteria commercial lenders use to analyze the approvability of a commercial loan request.
- Loan-To-Value Ratio
- Debt Service Coverage Ratio (DSCR)
- Credit
- Tenant Quality
- Environmental Assessment
The first ratio commercial lenders look at is the Loan-To-Value Ratio. The (LTV) equals the amount of the commercial mortgages divided by the market value of the property as determined by a commercial appraisal. Typically, Loan-To-Value Ratios for commercial real estate loans are capped at 75%. There is an exception in case of owner-occupied and medical office type properties where loan to value can be as high as 90%.
The second ratio that commercial lenders use when underwriting a commercial mortgage loan is Debt Service Coverage Ratio (DSCR). The most important component when underwriting a commercial loan request is the analysis of the subject property’s net cash flow.
Net Cash Flow = Effective Gross Income – (Expenses+ Reserves + Fees)
Specifically, the property must have enough cash flow to cover all the property expenses plus the new loan payment. For owner occupied commercial real estate, the businesses operating income is substituted for property cash flow.
The DSCR equals net operating income divided by debt service.
Typically, commercial lenders require a minimum DSCR of 1.20x. meaning, for every dollar ($1.00) in debt incurred, the property must contribute one dollar and twenty cents ($1.20) in cash flow to support the commercial mortgage payment.
The Third factor used in underwriting a commercial mortgage loan request is the Borrower Credit . While the key to a commercial mortgage loan is the net cash flow the property produces, the quality of the borrower does come into play. An underwriter wants to know credit score and whether the borrower has late payments, particularly on mortgages.
Credit can be defined as the combined personal credit of the borrowers. If a corporation, partnership, Trust, or other non-natural person is the borrower, than the credit of the entity will be considered as well, although to a lesser degree.
The Fourth factor used in assessing a commercial mortgage is the Tenant Quality. Who are the tenants? How long are the terms for the existing leases?
Commercial lenders are always concerned about risk. Properties with anchor tenants such as “ Home Depot”, “Banks” “supermarkets” with a long-term lease would be considered lower risk than a property without an anchor tenant, or one with tenants on short term leases. Short-term leases often results, in frequent tenant turnover and increased costs associated with turnover. Therefore, one of the first considerations in evaluating the strength of a commercial loan, is the strength and creditworthiness of tenants and the length of their leases.
The Final Factor used in assessing a commercial mortgage loan request is Environmental Assessment.
Most commercial properties require an Environmental site assessment in order to assure that properties do not possess environmental contamination that could diminish the value of the property.
