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Commercial Mortgage Underwriting Basics

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The Basics of Commercial Mortgage Underwriting

 

Commercial Loan Underwriting A Brief History
In the past, commercial loan requests were underwritten based on the commercial lender's internal credit policies and guidelines. The commercial lender, most often a bank, commercial mortgage bank, or insurance company would underwrite each commercial mortgage loan request on its own individual merits. The commercial lender would then look at their portfolio and determine the saturation level for the specific property type, delinquencies, and other related projects in the area and either approve the commercial real estate loan request or deny it.

 

Often a commercial loan request would comply with the commercial lender's credit policy but get denied because the lender may have reached saturation or may currently be experiencing a high delinquency rate for the subject property type.

 

Luckily, commercial mortgage lending has become more mainstream with many other funding options available for commercial real estate loans.

 

Cash Flow Analysis (DSCR) 
The most important component when underwriting a commercial loan request is the analysis of the subject property's cash flow. Specifically, the subject property must have enough cash flow to cover all the property expenses plus the new loan payment. The ratio used to calculate the cash flow for a commercial real estate loan is called the DSCR or DSC ratio. Typically, commercial lenders require a minimum DSCR of 1.20x. meaning, for every dollar ($1.00) in debt incurred, the property must contribute one dollar and twenty cents ($1.20) in cash flow to support the commercial mortgage payment.

 

Loan to Value (LTV)
Unlike residential lending, commercial real estate properties are viewed more conservatively. Generally, commercial lenders will require a minimum of 20% of the purchase price to be paid by the buyer when applying for a commercial loan. The remaining 80% can be in the form of a commercial mortgage provided by either a bank or commercial mortgage company. Some commercial real estate lenders will require more than 20% contribution towards the purchase from the buyer. What a commercial lender will do is subject to their appetite and the quality of the buyer and the property. Loan to value is the percentage calculation of the commercial loan amount divided by purchase price. If you know what a lender's LTV requirements are, you can also calculate the commercial mortgage loan amount by multiplying the purchase price by the LTV percentage. Keep in mind that the purchase price must also be supported by an appraisal. In the event that the appraisal shows a value less then the purchase price, the commercial mortgage lender will use the lower of the two numbers to determine the commercial loan size.


Credit Worthiness
For commercial loans made to a business - owner-occupied commercial property - businesses less than three years old, personal credit of principals will be evaluated. For non-owner occupied businesses, a single entity bankruptcy remote entity is usually formed to take ownership. The guarantors must have good credit and are required to provide income documentation. For stated income commercial loans, guarantors need not provide tax returns or personal financial statements.


Property Analysis
Fair Market Value and Fair Market Rent will be analyzed. Special use property may require additional underwriting. Age, appearance, local market, location, and accessibility are some other factors considered.

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