Simple Underwriting for Commercial Loans

Multi Family

Total potential income for all units, including rent, laundry, pet fees etc.
Number of units
Deduct 5% or actual vacancy or actual vacancy
EGI or Effective Gross Income
Deduct 5% or market cost from EGI for management fees
Deduct total of all expenses. Property taxes, insurance, maintenance, labor, legal/accounting etc.
Deduct $270 per unit per year for reserves
Result is NOI or net operating income
Enter the DSCR required Debt Service Coverage Ratio.
Divide the NOI by the DSCR for the maximum amount available to pay the mortgage.

Commercial

Total potential income for all commercial space, including common area reimbursements, percentage rents, property tax reimbursement etc.
Total gross interior square feet
Deduct 5% or actual vacancy or actual vacancy
EGI or Effective Gross Income
Deduct 5% or market cost from EGI for management fees
Deduct total of all expenses. Property taxes, insurance, maintenance, labor, legal/accounting etc.
Deduct $0.20 per square foot for reserves
Deduct $0.90 per square foot for Tenant Improvements and Leasing costs
Result is NOI or net operating income
Enter the DSCR required Debt Service Coverage Ratio.
Divide the NOI by the DSCR for the maximum amount available to pay the mortgage.

Commercial vs. Residential Mortgages

There is one fundamental difference between commercial and residential mortgages.

With commercial mortgages it is primarily the building and the cash flow it produces that qualifies the mortgage for funding not the borrower.

Commercial lenders originating long term commercial mortgages, as against short term hard money mortgages, are very concerned about the following:

	What is the net operating income of the property (NOI)?
	What is the debt service coverage? (DSC.)
	What is the occupancy rate of the property?
	How long are the leases?
	Who are the tenants?

Lets look at each of these in turn.

Net Operating Income (NOI)

This is the income produced by the property excluding interest payments, capital repayments and depreciation.

Debt Service Coverage (DSC)

What is the ratio by which the NOI exceeds the Principal and Interest payment.
If the NOI is $130,000 per year and the P and I is $100,000 per year, the DSC is 1.3 (130,000/100,000).

Lenders look for a DSC usually around 1.25 but it could range from 1.00 to 1.40. The lower number can occur when there is a triple-net leased property to a very financially strong tenant, like a Walgreens, where 100% of the income goes to service the loan.

Occupancy rate

Even if the property is 100% occupied, lenders will allow a notional vacancy factor of 5% or more. Some lenders refuse to lend on properties below a certain occupancy factor, like 70% for instance.

Lease terms

The longer the leases, other things being equal, the more financiable is the property.

The tenants

It doesn't take a genius to figure out why Microsoft or Bank of America is a stronger and more "bankable" tenant than Joe's Pizza Place.

How are buildings classified?

Office buildings can be classified by a combination of factors, the foremost being size, amenities and surroundings.

Class “A” Office Buildings

An ideal size for Class “A” office buildings is approximately 150,000 square feet, but they can be as small as 120,000 square feet. This square footage can be within one building or a group of buildings under joint ownership. Class “A” buildings should have the capacity to provide a reliable business environment. This means that they should be large enough to afford a full-time property manager, a full-time maintenance person, and a full-time cleaning person or building steward.
In Atlanta, Class “A” buildings always have covered parking.
Construction is also a major defining point in the classification of buildings. A tenant typically wants a “state of the art” building.In defining a Class “A” building, we must also look at the surroundings of that building. It must be located in a clean and protected environment; if the surrounding neighborhood is undesirable, the building can not be rated Class “A”. Amenities also play a large role in defining a building; parking is a critical element. Inadequate parking can kill a building. Quality and quantity of convenient amenities (banks, hotels, sandwich shops, restaurants and health clubs) serve to differentiate the higher Class “A” buildings from the lower Class “A” buildings.

Class “B” Office Buildings

Class “B” office buildings are very similar to Class “A” buildings. Usually, the only characteristic that differentiates a Class “B” building from a Class “A” building is the absence of covered parking.

Class “C” Office Buildings

Class “C” typically lack the size, quality or location to qualify as Class “A” or “B”

Non-Classified Buildings

There is a market for smaller office facilities in the 1,500 to 5,000 sq.ft. range. Where these buildings can function as office facilities, they are not office buildings. These buildings can never guarantee a good long term, hastle free, office environment for the office user.