How Commercial Real Estate Loans Work:

Here are some terms and concepts that will help you understand commercial lending a little better. Also please be sure to check out our Glossary. You can read the excerpts below for a rough idea. If you have any questions, Please feel free to contact us.

What is NOI (Net Operating Income)?

Net operating income or NOI is used in two very important real estate ratios. It is an essential ingredient in the Capitalization Rate (Cap Rate) calculation that is used to estimate the value of income producing properties... Another important ratio that is used to evaluate income producing properties is the Debt Coverage Ratio or DCR. The NOI is a key ingredient in this important ratio also. Lenders and investors use the debt coverage ratio to measure a property's ability to pay it's operating expenses and mortgage payments. A debt coverage ratio of 1 is breakeven. Most lenders require minimum of 1.1 to 1.3 to be considered for a commercial loan. From a bank's perspective, the larger the debt coverage ratio, the better.

What is DSCR (Debt Service Coverage Ratio)?

In commercial real estate finance, this is the main measure to determine if a property will be able to sustain its debt based on cash flow. Most banks will lend to a 1.2 DSCR, but at times with more aggressive practices you begin to see this number decreasing. A DSCR below 1.0 on a property indicates that there isn't enough cash flow to even cover the loan.

What is included in a Commercial Loan Package?

  • Executive Summary or Loan Request Summary
  • Personal Financial Statement from each borrower/couple/partner.
  • Last three years of personal federal income tax returns (no State returns required).
  • Last three years of business financials or federal tax returns (N/A if Schedule C Business).
  • Credit report and explanation of any derogatory items.
  • Digital photos of the subject property (if available).

What is the SBA 504 Program?

The CDC/504 loan program is a long-term financing tool for economic development within a community. The 504 Program provides growing businesses with long-term, fixed-rate financing for major fixed assets, such as land and buildings. A Certified Development Company is a nonprofit corporation set up to contribute to the economic development of its community. CDCs work with the SBA and private-sector lenders to provide financing to small businesses.

What is the SBA 7a Program?

A key concept of the 7(a) guaranty loan program is that the loan actually comes from a commercial lender, not the Government. If the lender is not willing to provide the loan, even if they may be able to get an SBA guaranty, the Agency can not force the lender to change their mind. Neither can SBA make the loan by itself because the Agency does not have any money to lend. Therefore it is paramount that all applicants positively approach the lender for a loan, and that they know the lenders criteria and requirements as well as those of the SBA. In order to obtain positive consideration for an SBA supported loan, the applicant must be both eligible and creditworthy.

Commercial Financing and Prepayment Penalties on Commercial Mortgage Loans?

Most commercial mortgage lenders making fixed rate commercial mortgage loans charge a prepayment penalty. The reason why is because the investors who buy commercial mortgage backed securities(CMBS) want a certain yield that is locked in. Why? Imagine you are a pension plan making actuarial projections to be sure you have enough money to pay your retirees. You need to know that you will earn a certain amount of interest. This is why you buy commercial mortgage backed securities.

Commercial Lenders Use the Lower of Purchase Price or Appraisal?

As far as 99.999% of all commercial lenders are concerned, the purchase price is the best indication of the fair market value of the commercial property. Your commercial loan will be based on the lower of the two - purchase price or appraisal.

How does Franchising Works?

The biggest advantage of franchising appears to be the reduction of risk you will be taking for your investment. This is because franchises typically get up and running faster, and are profitable more quickly. This can be a result of better management as well as a well-known name. According to the Small Business Administration (SBA), most small businesses fail because of weak management. It is in this area that the franchising option shines the most. When you lease a franchise, you are leasing that managerial know-how.

How Credit Scores Work?

A credit score is a number that is calculated based on your credit history to give lenders a simpler "lend/don't lend" answer for people who are applying for credit or loans. This number helps the lender identify the level of risk they may be taking if they lend to someone. While the same end result can come through reviewing the actual credit report (which lenders usually do), the credit score is quicker and less subjective. The system awards points based on information in the credit report, and the resulting score is compared to that of other consumers with similar profiles. With this information, lenders can predict how likely someone is to repay a loan and make payments on time.

How Credit Reports Work?

A credit report is an accumulation of information about how you pay your bills and repay loans, how much credit you have available, what your monthly debts are, and other types of information that can help a potential lender decide whether you are a good credit risk or a bad credit risk.

The report itself does not say whether you are a good or bad credit risk -- it provides lenders with the data to make the decision themselves. Credit bureaus, also known as credit reporting agencies (CRAs), collect this information from merchants, lenders, landlords, etc., and then sell the report to businesses so they can evaluate your application for credit. Lenders make their decisions based on different criteria, so having all of the information helps them ensure that they are making the right decision.

What is 'Underwriting?'

Underwriting is the process a lender uses to determine if the risk of lending to a particular borrower under certain parameters is acceptable. Most of the risks and terms that underwriters consider fall under the three Cís of underwriting: credit, capacity and collateral. To help the underwriter assess the quality the loan, banks and lenders create guidelines and even computer modules that analyze the various aspects of the mortgage and provide recommendations regarding the risks involved. However, it is always up to the underwriter to make the final decision on whether to approve or decline a loan.

How to Build a Construction Loan?

Writing an executive summary not only will give you a concise picture of the moving parts, but it also will allow you to shop your loan faster to more lenders as you search for the right funding source.
Every executive summary should contain detailed information about the following:

  • Project details, such as the number and type of units, proposed unit pricing,
    total project cost and cost per plan
  • People and entities involved in the project
  • Status of the project's phases, which include the site acquisition, plans and permits
  • Takeout Loan and exit Strategy