Commercial properties can be great investments for your business use or personal portfolio, but before you rush to put ink on an offer or refinance, understanding the commercial financing process might save you a ton of time.

Obtaining a loan for commercial property involves a similar process as a residential mortgage, though there are some considerable differences. Banks and lenders are more cautious about making commercial loans. Commercial property is used as an investment and the financial analysis required for lending is based on different criteria.

Commercial property can be much more difficult to analyze and sell than a home and the last things lenders want is an office building, car wash, convenience store or other piece of commercial property in their REO portfolio. This is due to possible changes of tenant vacancy or rents that can dramatically affect value. Because of this, underwriting is more stringent, loan to value ratios lower and stronger credit worthy buyers are required for this type of a loan.

Personal Debt Cover Ratio

One consideration for commercial financing is the Personal Debt Coverage Ratio (PDCR.) If you are the borrower this is your adjusted gross monthly income as a percentage of your expenses. The highest acceptable ratio for most lenders is a PDCR of 50% of total monthly debt to net income.

PDCR = Monthly Personal Debt / Monthly Personal Income

Loan to Value

Loan to Value (LTV) is the total amount borrowed versus the appraised value of the property. The appraised value often differs from the purchase price. The lender is not concerned about how good of a deal you have negotiated on the property, but about their level of risk based on the available equity in the property. Some lenders will loan as much as 80% of the value of a property though most have lower limits. In addition, on a purchase, many lenders will require you to provide proof of funds on hand for the difference, or down payment.

Knowing the lender’s criteria before making offers on a property or structuring a refinance will help you avoid spinning your wheels. You should request the LTV guidelines when you interview prospective lenders. Multiply the purchase price or appraised value, whichever is lower, by the LTV percentage to get the available loan amount.

Loan to Value = Total loan balances (all mortgages on property) / Fair Market Value (FMV)*

*FMV in this case is as determined by an appraisal or sales price-whichever is lower.

Credit Worthiness

Let’s face facts. Lenders want to make loans that make money with little or no risk. The old adage of you have to have money to borrow money is closer to the truth in commercial lending. Because these types of loans are considered riskier a stronger borrower financial position is usually required. Today, loans will require a personal guarantee even if the property debt services or a large corporation is making the purchase.

 

The Debt Service Coverage Ratio

The Debt Service Coverage Ratio (DSCR) is a financial ratio to determine a maximum loan amount. The DSCR is the net operating income from the property divided by the total debt service. Many lenders use a more conservative ratio and require the monthly property income to be more (sometimes substantially more) than the mortgage payment. Some of the factors they consider are the type of property, the likelihood of vacancies, the number and type of tenants at the property, and so on.

DSCR = Net Operating Income / Debt Service

Most lenders want the property to stand on its own feet. This means the property must produce enough income to pay all expenses including the loan payment without the borrower needing to provide any personal money to cover the costs. Today, lenders require the DSCR to exceed 1:1 in order to cover costs during any vacancies or unforeseen expenses. Depending on the type of property, its location and the borrower’s profile, these ratios can be a great deal higher. Remember that the higher the numeric ratio the less the investor can borrow.

Property Analysis

Commercial property appraisal is much different than residential appraisal and often costs thousands of dollars more. This is because this type of property is an investment and requires extensive calculations and research. Commercial properties are loosely defined as real estate that produces an income but excludes 1-4 unit non-owner residential.

The considerations for analyzing this type of property are numerous. There are the physical building aspects, the past, present, and future use of the property, zoning, traffic counts, actual and potential gross income, operating history and tax returns, EPA requirements, number of units and uses, parking lots, and many more. In addition, public and court records are searched for property liens and citations for infractions.

Tenant Analysis

Lenders will put tenants under financial scrutiny as well. All current leases and tenant types will be analyzed. Lease terms, including remaining life and rent ‘bumps’ are important. Who the tenants are plays a large part, too. In example, if a shopping center has a major grocery chain, it’s usually healthy for the center by increasing traffic and therefore creates perceived and real value. Also, the credit rating of the tenant, or lack thereof, enhances or deters value.

 

Preparing for the Costs of a Commercial Loan

Commercial loan fees commonly include:

Points – origination and discount fees: Range from 0-2 points depending upon the interest rate, and borrower/property strengths and weaknesses.

Underwriting – this can range from 0 to $4,000 depending on the amount of the loan request and transaction complexity.

Appraisal – All lenders require an appraisal. On complex commercial and construction loans, appraisals can cost up to $15,000 or more depending on the situation and property type.

Letters of Opinion – 0- $1,500

 

Contact Centurion Bancorp for any questions regarding a loan at help@centbanc.com

*** Disclaimer***  While we do our best to be accurate, we recommend that any information provided here is reviewed by an attorney or tax consultant.   Fees are generic and simply an estimate of transaction costs.