Introduction to Commercial Real Estate Loans by John Crefin

Author:John Crefin
Language: eng
Format: epub
Published: 2018-09-25T13:52:23+00:00

Banks like to see the 3 most recent years of financials (tax returns, profit & loss statements, etc.) to see what the cash flow trend is, however, they may accept the most recent 1-2 years of financials in some instances. Remember, OO properties generally require a minimum DSCR of 1.20-1.25 and NOO properties generally require a minimum DSCR of 1.25-1.35.

It is worth discussing pro forma cash flow. This is basically just projected or estimated cash flow on a property. It is also worth noting that banks do not like this as much as actual historical cash flow—this is another thing that burned them and got them into trouble during the Great Recession (bank auditors, in turn, don’t like it either). Banks usually will not use, or even entertain, this speculated cash flow because it is higher risk (i.e., unproven), however, they may use it in some instances (for example, with multifamily properties), but would likely discount the pro forma cash flow significantly (or at least a good amount) to feel comfortable with it. For example, you have a building that is 50% leased and 50% vacant. You have historical cash flow on 50% of the building (that is leased), and you think you can get 30% more of the building leased in the next 90 days (which would make it 80% leased, leaving only 20% vacant). The bank will likely not rely on 80% (50% leased + 30% projected) of the building being leased to determine cash flow, they will typically rely on just the existing 50% that is leased. Until the tenants are paying rent, it is not real, it is just projected.47 That being said, if you get a fully executed (i.e., signed) lease for the 30%, and the bank is comfortable with the quality of the tenant, the bank may rely on this cash flow because it is no longer projected cash flow since it is a source of cash flow backed by a legally binding contract (i.e., the lease).

LTV/LTC

Loan-to-Value (LTV) and Loan-to-Cost (LTC) were discussed before,48 but as a refresher, they are:

LTV = Loan Amount/Value of the Property

LTC = Loan Amount/Cost of the Property

Banks rely on these ratios to determine the maximum loan amount they will give to a borrower. The LTV will tell a bank how much equity a borrower has in the property, and the LTC will tell them how much cash (or “skin in the game”) a borrower has in a property. In theory, these ratios would be identical, but due to various market conditions and cycles, they often do not. That being said, the maximum LTV and maximum LTC a bank will allow is usually about the same (i.e., maximum 75% LTV and maximum 75% LTC).49 For example, let’s say you paid $1,100,000 for a property and it has a value of $1,000,000 and the maximum LTV and LTC for the bank is 75%, you would have the following limits for your loan:

LTV = $750,000 ($750,000/$1,000,000 = 75%)

LTC = $825,000 ($825,000/$1,100,000 =

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