I wanted to provide a “snapshot” of how we qualify a loan for a commercial property.
First, a commercial property is defined as that having 5 or more residential units, or a 1-4 family residential “mixed use” property where there is a commercial space incorporated into the property (think “corner store” with apartments upstairs), or any other type of non-residential property. That would include: hotels, gas stations, office buildings, strip-retail, warehouses, and factories.
For the purpose of this post, I will limit myself to a description of qualifying for an apartment building loan, say, six families.
Here’s what we do to qualify the loan:
1. Verify existing rentals in the property. We get this information from the Seller of the property. This is checked against New York City DHCR filings (if the property is in the confines of New York City). We may request leases.
We then multiply the monthly rentals to determine the annual “gross” income.
2. Next, we subtract an automatic vacancy percentage, usually 5% of gross income. Thus we create an “effective gross income” of the property annually.
3. We outline the expenses of the property including property taxes, insurance, utilities (for common areas), management fees, water/sewer, fuel, and various other miscellaneous fees involved in the operation of an apartment building.
We define an annual figure for the expenses, then subtract this from the effective gross income.
4. The bottom line number is the figure used to qualify a loan. Inherently, the rental income should be sufficient to sustain income for the property within a “Debt Servicing Ratio” predetermined by the Lender.
5. Appraisal value is not determined purely by market valuations. Instead, the appraiser must base the final valuation on the Income and Expense approach. That is, as in item 4 above, the net income must be sufficient to support the value.
This last part is where we run into trouble most often. In this crazy overheated market, we have such properties being sold for more than the rental income will sustain. And it is not just a matter of your having made a large downpayment. I have a client who is putting 50% downpayment, yet the appraisal will come in far short of the purchase price, thus requiring the Lender to lower the allowable loan amount. Unfortunately in the case of this client, that lower loan is $50,000 less than what he needs to acquire the property.
Of late there have been an increase in “limited documenation” or “no income verification” commercial loans. Lenders are responding to the market conditions. The money is out there to be had, but the Lenders view these loans as a riskier venture since the income of the property may not currently sustain the loan. Accordingly, interest rates are higher.
I received offers from three lenders this week for the client described above. The loan amounts met his needs, but the interest rates were, 7.50%, 7.37% and 7.00%. The loan types varied from variable rates to short term fixed rates.
I know a fourth Lender where I can obtain a substantially lower rate, but they are hitting the value of the property with the Income and Expense approach, thus offering my client the $50,000 lower loan.
There you have a “snapshot” on commercial loans. More to come, especially about the loan types and the process of obtaining a commercial loan.