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Buying A Commercial Property That Doesn't Seems To Cash Flow
| | Monday, April 16, 2007 @ 08:03 AM EDT
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Contributed by: James hunter
James hunter Properties
Read more archived articles about Credit and Finance
Sometimes it seems that commercial mortgage lenders will turn down what we think would make a perfectly good commercial mortgage candidate. Or they will offer far less than what's necessary to make the commercial mortgage financing work.
On my desk today is a loan for an apartment building for sale with a
rent roll of $73,800 and expenses of $19,471.
What the commercial real estate broker listing the property reported as
Net Income is really Effective Gross Income (EGI). The real Net
Operating Income (NOI) is calculated after deducting for vacancy
factor, management, maintenance, and reserves.
In the NY area we use a vacancy rate of 5%. Other parts of the
country experience real vacancy factors ranging from 5-15% at any
time.
When factoring in management reserves, even a self managed building has
a cost associated with management. Sweat equity has to figure into it
somewhere.
As for maintenance every building needs some maintenance for waste
removal, plumbers, minor repairs, painting, etc. These things do and
can costs money.
One thing most commercial property owners and future landlords failed
to factor in their equations when calculating expenses truly
are the replacement reserves: A brand new roof or boiler may have
a 25 year life. But that money had to come from somewhere and it needs
to be accounted for. To get that figure you divide the cost into 25
years and budget that amount for replacements.
If you don't factor these items in, don't worry. All commercial
bank underwriters will put them into the calculations as debt service
deductions. Most commercial mortgage lenders have a DCR requirement of
at least 1.10. What that means is that the building needs to bring in
1.10 for ever dollar of debt service.
The example above yields somewhere around $3100 monthly for
debt service. At 7% for 30 years , the loan is around $470,000. The
sales price is $900,000. Its debt service using a traditional formula
won't qualify for the loan the property owner is asking for.
So what do you do! Well their a few smart unconventional lenders
who will underwrite this loan with low or no debt service expense ratio.
How is this possible you ask? Well they simply view it as an equity
deal and they value the property at the appraised value and not its
income producing value. They will usually factor in that rents may not
be at market value and use a building projected cashflow in the future.
At the same time to protect their interest they will make the loan with
a few stipulations. The loan to value will usually be around
80% for mixed used and multifamily property types, and 75% for
all other commercial property types. And the borrower's credit score will
have to be at least 650. However most commercial lenders will allow you
to do the deal stated and have a seller held second mortgage for a
combined loan to value of 90%
Most commercial loan of this nature are usually full re coursed and
the underwriters usually factor in the person's financial and
personal credit history as evidence that they can manage the project
correctly.
To make it short and sweet the types of deals that qualify for this
type of loan are because of the equity in the property
and not because of its loan to debt service characteristics.
Do you not want to show debt service on your next property acquisition
or are trying to refinance a loan where the property doesn't debt
service.
To help you in your path look for commercial lenders who based their
lending on low to no debt service coverage and that that will make the grade
equity wise.
Note: James Hunter is a commercial mortgage consultant for Alpha
Omega Financial. He can be reached at 516-404-3268
Alpha Omega Financial specialized in the high loan to value no debt service commercial real estate loans up to 90% loan to value.
Word Cloud:
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