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Commercial Lending Frequently Asked Questions

How much money do I have to put down on my Purchase?
What about an SBA loan?
How do I calculate the Net Operating Income of my property?
What does Debt Service Coverage Ratio mean?
How do I calculate Debt Service Coverage Ratio?
What is a “Cap Rate”?
What does “Stress Test” mean?
What kind of credit do I need in order to qualify for a commercial loan?
Will I be required to buy Environmental Insurance?
What does “Non-Recourse” mean?

Q. How much money do I have to put down on my Purchase?
A. Most commercial loans will only provide financing up to 85% of your purchase price. However, this figure varies based upon the type of property. The maximum percentage is typically reserved for multi-family properties, while properties considered “more risky” such as restaurants and gas stations may only be eligible for 70-75% maximum financing. However, in both cases, a seller is typically permitted to offer privately-held financing of up to 5-15% above what the financial institution will offer. However, this may increase the pricing of your institutional loan and lower the percentage of financing that the institution is willing to extend to you.

Q. What about an SBA loan?
A. SBA loans typically offer a higher percentage of financing than traditional banks do, and their rates are typically much better. But, there is a catch. The SBA loan process is arduous and lengthy, and loan fees can be higher than traditional lending venues. Even more important, the SBA loan will typically require you to “cross-collateralize” your personal residence or other properties that you may own now or even in the future, that may have little or no mortgage on them. In this case, it will be very difficult, if even possible, to access equity you may have in these other properties, should you need to, without having to take extensive and frustrating steps to do so. SBA loans also fit a very specific type of borrower. It’s almost like trying to fit everyone into a size 6 dress or size 28 jeans. It’s perfect for some, but there are many that this program just doesn’t fit.

Q. How do I calculate the Net Operating Income of my property?
A. Without getting too technical, we’ll give you the basic formula. Add up all of the income generated from your property such as rent, fees, etc on an ANNUAL basis. Then subtract all of the expenses associated with operating this property such as repairs, utilities, and taxes and what you have left over is your Net Operating Income, also known as “NOI”. Keep in mind, however, that your NOI does not take into account your mortgage payment on the property. That number is used in another calculation process known as Debt Service Coverage Ratio.
The more technical formula is: Potential Gross Income + Other Income - Vacancy - Real Estate Taxes - Operating Expenses = Net Operating Income

Q. What does Debt Service Coverage Ratio mean?
A. To put it simply, Debt Service Coverage Ratio, otherwise known as DSCR, is the number that indicates how profitable the commercial property is. For example, a DSCR ratio of 1.50 means that for every dollar you spend on the property to keep it running, you are bringing in 1.50 in income. As a standard, the lowest DSCR that most lenders will accept is 1.25.

Q. How do I calculate Debt Service Coverage Ratio?
A. In order to calculate a Debt Service Coverage Ratio you will need to know what the annual mortgage payment on the property will be. You will take the annual mortgage payment on the property and divide it into your Net Operating Income. The number you end up with should have a decimal in it. For example, if your Net Operating Income is $763,456 and your annual mortgage payment is $435,000, then your DSCR is 1.755 which is typically a good DSCR to most lenders.

Q. What is a “Cap Rate”?
A. “Cap Rate” is short for capitalization rate. Essentially this is the market rate for your type of property in your subject property neighborhood. It is one of the ways appraisers determine the value of your commercial property. This number will vary dramatically by neighborhoods and property types. It is reflective of the supply and demand for your type of property in your particular neighborhood. For example, the cap rate in a college town on an apartment complex will be much lower than a cap rate on an apartment complex in rural Nebraska as the supply and demand will be much higher in the college town. The lower the cap rate, the better the news is for you. Here’s the basics of why. The appraiser will take your Net Operating Income of the property and divide it by the cap rate (as a tenth. IE: a cap rate of 8.5 will need to be divided into your NOI as “.085”). So obviously, the smaller the number is, the more times it will divide into your Net Operating Income. The final number of this calculation is usually a good indicator of the value of your property. For example, if the NOI of your property is $245,000 per year, and the cap rate for your property is 8.5, then the estimated value of your property is $2,882,352. This means that you will need to provide an accurate Operating Statement to your appraiser in order for them to properly calculate the value of your property. Keep in mind, this is only one approach an appraiser takes in determining the value of your property.

Q. What does “Stress Test” mean?
A. If you are applying for a loan that starts at a low adjustable rate, you may need to qualify at a worst-case-scenario rate. For example, if you were to start at a Prime + 2% rate, you would probably have no problem qualifying for the loan if Prime is at 5.25% since the rate would then be 7.25%. However, since you’re applying for an adjustable rate mortgage, the financial institution will want to make sure that you can still easily make your payment should Prime increase because obviously your rate will also increase at that time. So, the underwriter may underwrite the loan qualifying you with a “stress test” or “qualifying rate” of 10.25% in order to assure them that even if Prime were to increase dramatically, you would still be able to make your mortgage payments.

Q. What kind of credit do I need in order to qualify for a commercial loan?
A. If you were to deal directly with a bank or other type of financial institution, that institution may have a set requirement for a particular credit score or credit profile that you may be required to have. However, with most commercial loans that are brokered, the credit is not one of the first considerations in qualifying you for a commercial loan. The first consideration is the property type. The second is the income of the property. The third is your financial net worth and personal cash flow. And finally, your credit. Your credit score isn’t as important as your credit history. Having tax liens, derogatory public records, and recent late payments report on your credit is a huge detriment in your approval process. However, mortgage-lates on any property you own are equally as serious and may be the reason why you will be turned down for a commercial loan.

Q. Will I be required to buy Environmental Insurance?
A. Environmental Insurance is, unfortunately, a requirement for most commercial loans. However, the insurance cost should be minimal if your property is not known for environmental hazards. For example, an office complex would have a much lower premium for environmental insurance than a gas station.

Q. What does “Non-Recourse” mean?
A. In simple terms, a Non-Recourse loan is one in which, if the loan is defaulted on, the lender can only go after the property used as collateral, as opposed to a Recourse loan in which the lender can go after the company or business entity for repayment of that loan, or a Full or Personal Recourse loan in which the lender can go after the owners of the business entity and guarantors. Loans on properties other than multi-family properties typically require Full Recourse, meaning the guarantors and owners of the business will have to ensure timely payment of the loan.