Congratulations on your decision to dive into the commercial property investment business! While there are many exciting times ahead for you, you will also find there can be some big frustrations as well. Attaining funding is often the most stressful time for any commercial property investor, as well as the one single biggest frustration. However, by better understanding the investment property mortgage loan process you can move easily through the frustrations and on to becoming an investment property owner more quickly.
Similarly to procuring residential home mortgages through a mortgage broker or a bank, you will likely be dealing with a commercial property broker or lender for your commercial property purchase. While your broker and your lender can be of some help to you, if you can do some homework before looking for financing, you can decrease your stress level immensely. This allows you to go into the process better knowing what you can get easy approval for. And, if you are searching for a more complicated approval, you can come to the table with all of the facts the lender is going to want.
Part of doing your homework, prior to talking to a lender, is to understand that there are three common ratios which commercial lenders all use to judge the risk of an investment. If you are educated about these ratios you can come to the table with your lender in a positive position by being significantly prepared. Your preparation will show the lender that you know what you are doing and this will make them more likely to do business with you.
Let's take a moment and examine these three ratios more closely:
The Debt Coverage Ratio (DCR)
The debt coverage ratio (DCR) describes to the lender how much income the property is producing when compared to the cost of the total debt on the property. The DCR is calculated by taking your net operating income and dividing it by the total of all of the mortgage debt on the property.
Most lenders want to see a DCR of at least 1.2 in order to consider lending money on a property. Any DCR below 1.2 indicates to the lender that the property is probably going to be loosing money. Lenders do not like to lend on a property with that high of a potential for losing.
The Loan-To-Value Ratio (LTV)
The loan-to-value ratio (LTV) is the same as you might associate with residential lending. It is simply the total debt on the property in comparison with the property's current market value.
While residential lenders are okay with less than 75% LTV, you will find that commercial lenders use 75% LTV as the least they will generally lend on. This means that you will have to retain 25% untapped equity on the property.
Some commercial lenders will go higher than the 75% standard, but you will likely pay more for the debt than you would if you had stayed below that percentage.
The Debt Ratio
Generally for smaller commercial projects the commercial lenders will require you to submit a personal financial statement as a guarantee on the potential loan. The debt ratio will be your own personal monthly housing expenses divided by your own personal monthly gross income.
The debt ratio shows the lender how much money you have personally which is not already allocated to your living expenses each month. Most commercial lenders will not lend to you if your personal debt ratio is above 25%. Some have been known to lend up to 36% however, again, you will pay a premium for that loan.
Before you approach a lender you will want to understand these three ratios and run the numbers for your unique situation. By determining if financing will be easy or difficult, from the start of your project; you can better work with the commercial investment property mortgage lenders. Any loan is possible, but they are more probably when you have done your homework before talking to a lender.