Commercial Property is one or more buildings (with the land) whose intended use is for profit-generating activities. This property type includes apartment complexes with five or more units, office buildings, warehouses, storage unit complexes, and retail buildings (e.g., convenience stores and shopping malls).
Qualification for a Commercial Loan can widely vary from lender to lender. Please get in touch with us so we can place you with the right lender whose requirements can fit your exact situation.
Because the Borrower's Income is primarily not qualifying for the loan, it is crucial to understand how a Commercial Lender's mind works.
Although Commercial Lenders pull your credit and want to know your current income, they do not base their Commercial Lending Decisions on your FICO Score or how much your gross yearly income is. Instead, they qualify your loan based on the cash flow of the Commercial Property. Often, they want to verify that the property income is at least 120% to 125% of your total expenses to run the property. The Lender turns this into a ratio of Expenses to Income termed your Debt Service Coverage Ratio (DSCR). For example, a Lender can express this as a DSCR requirement of 1.20 or 1.25. Each Lender can apply a different DSCR Requirement.
Lenders derive the value of a Commercial Property from the net cash flow it produces, not what someone is willing to pay for it. For example, during a recession, your cash flow may decrease below its current level, which means your commercial property value can fall. Therefore, commercial lenders want a buffer to hedge against this future potential loss of value. Because of this, Lenders will limit their loan amount to no more than a percentage of the current estimate of the property’s value. This percentage is termed a Loan to Value (LTV). In Commercial Lending, a 75% LTV is typical.
Commercial Lenders equate the current value of a property to a future projection of net income that the property will generate. Dividing the Annual Net Operating Income by the cost of a piece of property creates a Capitalization Rate, aka the “Cap Rate.” By comparing Cap Rates between similar commercial properties, a Lender can estimate if you are paying too much for a property. For each property type, each Lender may use a unique Cap Rate to determine an appropriate range of value.
When a Commercial Property secures a non-recourse loan, a borrower is not liable to pay any deficiency amount if the loan defaults. The Lender can seize and sell the property, but if the collateral sells for less than the debt, the Lender cannot seek that deficiency balance from the borrower. Each Lender will use their criteria to establish a non-recourse loan. Typically, a lender will charge a slight increase to a mortgage rate in exchange for a loan without recourse.
Sometimes Commercial Lenders do not operate inside entirely black-and-white guidelines. A Loan Committee can make each Decision to fund or not. Depending on what is happening with other loans the Loan Committee has funded, a Lender may approve or disapprove of your loan. Even if your numbers make sense, a Lender can decline to fund. It can have nothing to do with your figures or yourself but have everything to do with other similar types of loans that the Lender acquired that have not yet performed well.