What every borrower should know about CRE ratios.
All lenders have particular guidelines which they often refer to when trying to decide if a certain borrower will be given a loan.
Usually, banks, credit unions, and other traditional lending institutions use much stricter models than private lenders, but everyone uses something, and it's definitely advantageous for borrowers to know as much as possible going in.
As a general rule, commercial real estate loans are concerned with much higher dollar amounts than residential loans. Instead of hundreds of thousands, we are dealing with millions of dollars, usually used to purchase and/or develop properties and, as may be expected, there is a correspondingly higher risk associated with such loans.
Commercial lenders, especially of the conservative variety, tend therefore to be more analytical and prudent when considering loans of this magnitude. That's why borrowers as well as brokers should be aware of ratios, which are what all commercial lenders use to help them arrive at two important conclusions: 1) whether or not a borrower will receive a loan and, if so 2) how much. There are three such ratios of particular importance.
Let's start with DCR, the Debt Coverage Ratio. This applies to the property under consideration. Specifically, how much income it is producing compared to the debt service, or the amount paid each month towards the mortgage, This ratio is commonly expressed as the NOI (Net Operating Income) divided by the total debt service.
The NOI is defined as the total income remaining from the property after paying all operating expenses. You can calculate debt service via the mortgage terms, including interest rate, loan length, and payment frequency.
Simply put, the higher the DCR, the easier it will be to cover the debt service. Most traditional lenders insist upon a DCR above 1.2 before they'll consider it an acceptably safe investment; whereas any figure below that will indicate that the property is questionable. Typically, lenders will not make loans for projects that cannot cover their debt service.
Next, we have the Loan-To-Value (LTV) ratio, defined simply as the sum of all mortgages divided by the property's market value.
Someone applying for a commercial loan must determine how much value of the property they will actually be borrowing, as opposed to how much will remain as equity.
An LTV of 75% is considered a very good number and is, coincidentally, the LTV that some private lenders offer, including my own company.
If you are able to find an LTV greater than 75%, consider yourself very lucky. It's a fact, however, that lenders' rules and regulations can vary widely. It all depends on how much they're willing to risk. Most banks, in fact, offer substantially lower LTVs than 75%, even when the risk factor is considered to be low.
Lastly, we have the Debt Ratio, and it's usually used for smaller commercial ventures.
In these types of loans, some commercial lenders may ask you for personal information, such as your monthly personal income and debt, determined by dividing monthly housing expenses by gross monthly income. This will reveal the relation of debt to income.
Speaking generally, most commercial lenders will refuse a debt ratio greater than 25%, as it will probably be prone to budgetary problems.
Conversely, some commercial lenders will accept DRs of 28%, and some will go to 36%. This is uncommon, however, and the lower your DR, the better the chances of your loan getting funding.
It always helps for borrowers to do their homework, and derive some inkling of what lenders expect. This way, they can more successfully find a lender willing to give them a loan.
The easiest way to do this is to simply call some lenders and talk with them. Find out if they offer special rates or, even better, ask for actual numbers of the ratios they require when deciding to approve a loan.
Just remember that each lender is different, and each has different standards. So do your due diligence, speak to many lenders, and carefully review each application, with an eye to finding the best fit for you.
Also remember that direct private lenders can offer you advantages that traditional lenders cannot, namely speed and flexibility. You'll have your money faster, even if conventional lending institutions will not deal with you.
Private lenders will typically lend money even on highly risky loans. After all, the higher the risk, the greater the potential return.
Regardless of which commercial lender you choose, always walk in with carefully prepared information and documentation.
Your lender will love you for it.
BY KEVIN WOLFER, co-CEO
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|Comment:||What every borrower should know about CRE ratios.|
|Publication:||Real Estate Weekly|
|Date:||Aug 15, 2007|
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