Ratios To Know When Applying For Commercial Real Estate Financing

Financing commercial real estate is a little different than getting a mortgage for your primary residence, and there are a few specific ratios to know when you're comparing quotes and applying for financing. Lenders will often want to know one or several of these ratios before they extend a commercial real estate financing offer.

Loan to Value

The loan to value (LTV) ratio is a measure of the loan's amount compared to the property's value. It's calculated as follows: loan amount / property value x 100% = LTV. For example, consider a $1 million loan for a property that's worth $1.4 million. In this example, the LTV is 71.4% ($1 million / $1.4 million x 100%). 

Each lender has a maximum LTV that they'll allow, and they'll only write loans that have LTVs at or below the maximum amount. Going over the maximum presents the lender with too much risk as the borrower doesn't have enough equity in the property to ensure they'll take care of it.

Lenders will consider the LTV of a specific loan and property. If you have a portfolio of other properties, they might also want to know the cumulative loan to value (CLTV) of your portfolio. The CLTV is calculated as follows: (sum of all loan amounts) / (sum of all property values) x 100% = CLTV.

Debt Service Coverage Ratio

Lenders use the debt service coverage ratio (DSCR) to measure how easily a property's income can cover its loan payments. To calculate the DSCR, you must first know the net operating income (NOI) and the debt service.

NOI is a measure of how much a property makes, and is calculated with the following formula: recurring revenue - operating expenses = NOI. Recurring revenue includes all regular sources of revenue, such as rent payments, parking fees, vending machine sales, and other regular income. Operating expenses include everything that's necessary to run the property as it is.

Debt service is the monthly debt payment(s) that are made on a property's loans. Any loans held against the property are included in this. With these figures tabulated, you can calculate DSCR according to this formula: NOI / debt service = DSCR. Lenders will have minimum DSCR ratio requirements in order to ensure that a property's cash flows are sufficient enough to make the property's debt payments.

To learn more about real estate refinancing, contact a service near you.