Underwriting a Commercial Loan

23 Oct

Underwriting a Commercial Loan

How Commercial Mortgages are Underwritten

Commercial mortgages are underwritten differently than residential loans, hence the loan package needs to be assembled in a different fashion. When dealing with improved commercial real estate the property’s net income is the most important factor in underwriting the loan.

Debt Service Ratio

The property’s net income determines its ability to pay the monthly mortgage payment. This is commonly referred to as the debt service coverage ratio (DSCR) or the debt service ratio (DSR). For this reason a borrower’s income is less important than the commercial property’s net income. Some lenders will take into account the borrower’s income and apply it as a global debt service coverage ratio.

Common Mistakes

Commercial mortgage brokers do themselves a disservice when they fail to acquaint themselves with the loan they are submitting. Often a mortgage broker will call saying that they have a construction loan on a piece of property. When the lender reviews the documents, they see that the loan is actually a development loan on a piece of raw land. This casts a bad light on the broker, lenders are busy people and see many deals in a day. If a lender is only making construction loans, yet they are submitted a development deal it is often a waste of their time. Broker’s that don’t understand the deals they submit are perceived as lazy, unintelligent, after a quick buck, or some combination of these elements.

Required Documents

Individual commercial lenders will give different weight to different elements of the loan package. It is best to assemble a complete package before submitting a loan to a lender. Knowing in advance what documents and information a lender will want is also helpful.

Executive Summary

Writing an executive summary is always helpful. A complete package may include hundreds of pages of data. It can be difficult to extrapolate the loan amount and the purpose of the loan from all that data. The executive summary should include a description of the property including square footage, number of units, location, and the lot size. The loan amount, property value, and purpose of the loan should also be stated. An income summary should also be included in the executive summary of the commercial loan.

Standard Documents

These documents should be included in all submitted packages:

Loan Application
Borrower’s Financial Statements
Borrower’s Resume
Borrower’s Tax Return for 2 years
Borrower’s Credit Report
Preliminary Title Report
Property’s Operating History for 2 Years
Property’s Rent Roll
Property’s Tax Return (if not included on borrower’s)
Purchase Contract (if a purchase money loan>
Current Appraisal - Before paying for an appraisal you should determine if the lender only accepts appraisals from “approved” appraisers.

Useful Information

When seeking commercial loan refinancing it is also useful to know:

Current Loan Amount
Original Purchase Price & Date
Use of Additional Funds (if a cash-out refinance)
Justification of Value - If the property value has increased dramatically, why is that? Better tenants? Capital improvements? Appreciation?

Summary

Commercial lenders want proof that they should make the loan. The property’s income or future value should justify the loan amount requested. Commercial lenders are not allowed to make loans based on a broker’s enthusiasm or the borrower’s need for the loan. The numbers don’t lie and often tell the true story of the loan. As Joe Friday says, “The facts ma’am, just the facts.”

Responses to “Underwriting a Commercial Loan”

nuShack
October 23rd, 2007 at 6:44 pm

That’s a pretty interesting article. I know very little about commercial real estate, so it’s good to see some more information on the subject.

Navarr Montgomery
April 6th, 2008 at 12:09 am

Yes it’s a pretty good article, but what about due diligence fees? Do these fees always have to be upfront. I understand that people have to be paid but those fees are never 100% refundable. If a guy has all permits by the state and town, blueprints, appraisal, use of proceeds etc. and you have no money to put up for commitment or due diligence fee, does that mean no deal. What about the “numbers dont lie” phrase. If the equity is there and the completed project has a outstanding profit,y not cut the crap and fund the money. Why would someone put up 30k+ without gauranteed approval. Yes people do it but it keeps clients skeptical of the bank. My client is in the midst of chap 11. He doesnt have the money for these upfront fees but his numbers dont lie. Whats the problem.

Navarr Montgomery
April 8th, 2008 at 8:23 pm

Due diligence fees should always be atleast 50% refundable under any circumstances, and all other fees such as upfront commitment fees etc. should be tagged onto the loan. If the numbers dont lie, why not get the deal done and get paid at the closing.

Donna - Mortgage loans
July 21st, 2008 at 1:51 am

A very nicely explained article. Most of the people would like to get their applications processed through brokers and brokers should know the nature of the loan and the terms well in advance. This way both the lender and borrower will save time, efforts and money. More so if dealing with commercial loans.

Donna

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