In troubled economic times, there have been a lot of newsmakers from Wall Street bailouts to home loan modification programs.

However, one troubled market has slipped under the radar for too long: commercial real estate. According to the Wall Street Journal, real estate prices have dropped by over 43% since a 2007 peak. And foreclosure rates continue to rise.

Unlike the housing market, the term “loan modification” has been slow to catch on with the commercial sector. In fact, it seems many commercial property owners don’t even realize they have an option when a property becomes distressed.

The refinance market is dry and with values plummeting, it can seem impossible to get the bank to approve new financing. Many property owners are hearing “no” and simply accepting that as the final answer.

Commercial Debt Restructuring is a Viable Option

When the refinance application comes back denied, that’s not the end of your rope. What it means is you need to pursue other options. A loan modification is basically a way to restructure your commercial debt even when no other financing alternatives prove viable.

Making it work ultimately comes down to whether or not you can show your lender a justifiable reason to work something out. And in this case, “justifiable” is really just another word for “financial.”

After all, this is a business decision that has to make sense for both parties and in the end, it will come down to your ability to afford payments on the property going forward.

For example, if you’re so far upside down that even a modification won’t bring you back in line with a realistic income and expense report, the bank is going to say no.

Negotiating With the Bank

You can either negotiate directly with the bank yourself or utilize a third party. Usually, results are easier to come by with a third party due to expertise and relationships. There are certain things the bank wants to see and knowing how to properly present that is crucial.

Your rent roll and income and expense report will basically tell the story, but there are right and wrong ways to do it.

Granted, hiring a third party means there is some expense involved, but the fees they charge can be quickly recouped by the savings you get with the lower monthly payments.

Ultimately, you have to make the decision that gives you the most comfort and assurance.

By: Jerry Rodgers

About the Author:
Jerry is passionate about the commercial real estate market. You can learn more about commercial loan workout options and get a free consultation with a commercial debt restructuring specialist.

Commercial loan underwriting guidelines come down to cash flow ( DCR), loan to value (LTV), credit worthiness and property analysis. Although the process to evaluate a potential commercial mortgage is basically the same from one bank the next, their various appetite for both risk and minimum rates of return are what separates one bank from the next.

Underwriting Commercial Loan Cash Flow

Cash flow is paramount to underwriting commercial loans. Within the industry the cashflow analysis is refereed to as the Debt Coverage Ratio ( DCR). For both owner occupied and investment transactions underwriters normally want to see ratio’s above a 1.20. In other words, for every $1 of mortgage debt the property or business has to have $1.20 of net income to meet the mortgage payments.

Debt coverage ratio minimums vary from one lender to the next, property type and occupancy (investment or owner occ). “Riskier” property types such as hotels or car washes will be required to have higher cash flow levels, ie DCR at or above 1.3.

Credit Worthiness

The borrowers personal and business credit worthiness is also important and will be heavily scrutinized. Personal credit scores have become a bigger issues as the acceptance of the three bureau have become widespread. D & B’s as well as other measures are normally used to asses the creditworthiness of businesses that are involved.

Property Analysis Commercial Underwriting
Fair market rent and fair market value is heavily measured. Condition, age, appearance, town population, market trends as well as other more property type specifics are examined.

Commercial Underwriting – Loan to Value

Loan to value is simply the value of the subject property vs the loan amount. I.e if the property is worth $2,000,000 and the loan amount is $1,500,000 the LTV is 75%. This is a huge issue within commercial loan underwriting and a big separator between lending institutions. Some lenders will get very aggressive with this while other will be very conservative.

The property type has a major influence on loan to values that are offered on commercial loans. For example restaurant loans will normally be capped at 65% while more general purpose properties such as retail will be limited to 75%.

Commercial underwriters will give more leeway to buildings that are owner occupied vs. investment properties. Loan to value on purchase can go as high as 90% on owner occupants vs 75% on investments, for example.

By: Jeff Rauth

About the Author:
Jeff Rauth is President of Commercial Finance Advisors, Inc out of Birmingham, Michigan. He specializes in Commercial Real Estate Loans between $400,000 – $5,000,000. Offers unique loan programs such as Commercial Second Mortgages, Commercial 30 Year Fixed and 90% non SBA financing, Commercial Equity Lines. 248 885-8797 or at SBA 7a Loans or commercial loan underwriting or 90% commercial loans.

If an investor buys a single family residence to live in, the property will generate no income. Therefore the lender qualifies the borrower with regard to the ability to make the payments.

Likewise, if an investor buys a residential property as a rental and the tenant moves out, the borrower will be required to make the mortgage payments until the property is re-rented. Therefore it should be no surprise that the lender is going to qualify the borrower with regard to the ability to make the payments. A single family rental house is either 100% rented or 100% vacant. The lender will look at the worst case scenario (100 % vacant) and determine whether the borrower can make the payments from his/her own income.

In CRE, it is the property that primarily qualifies for the loan and not the individual borrower. While CRE is purchased for potential appreciation, the actual cash flow called “Net Operating Income” (NOI) is what gives CRE its value. NOI is what lenders are considering when making a loan on a property with the individual borrower’s financial situation as a secondary consideration.

In CRE, the mortgage payments are referred to as the Annual Debt Service (ADS), and are made from the NOI of the property. Paying the mortgage in CRE is called “servicing the debt” or “debt service.” Rents are collected. Expenses to operate the property are paid. The remaining cash flows called NOI are available to service the debt.

Commercial property is rarely 100% vacant nor 100% rented. There are exceptions of course! In CRE, the property can have significant vacancy and there may still be enough cash flow necessary to service the debt.

The lender considers numerous factors when qualifying a property. What are the typical vacancy and rental rates in the area? How does this building compare to those rate? What is its current vacancy rate? How long does it typically take to get units rented? Even with vacancies does the property cash flow and if so, at what vacancy rate will it no longer cash flow? Whew! The lender has many considerations and not one of these was your FICO!

What the lender may look at is the investor’s character. In other words, if the NOI is sufficient to service the debt, will the investor use that cash to service the debt or will the investor buy a fancy new car instead? The lender may also consider the experience and track record of the investor. Does the investor understand how to operate this type of CRE and if not, has competent management been retained? That NOI must be protected!

The lender will also likely require the investor to retain a portion of the remaining NOI as “reserves.” Most lenders will require those reserves to be deposited with the lender so they can be easily used to cover any unexpected shortage in cash flow, allowing the investor to continue to service the debt.

Additionally, the lender is going to apply a margin of safety in their loan underwriting to assure that the amount of debt service the investor is obligated to make is less than the cash flow the property produces. To do this, they will apply what is called a “Debt Service Coverage Ratio” also called “Debt Coverage Ratio” (DCR) to determine the amount they will loan on the property.

ADS / NOI = DCR

Sample Calculation: $100,000 NOI/$80,000 ADS= 1.25 DCR

DCR is defined as the ratio of annual; cash flow to ADS. Lenders establish their own minimum DCR’s for the loans they make and it will vary between property type, location and borrower. Typically lenders want to see more than a 1:1 ratio. This means that they want some amount of cash flow greater than the amount necessary to service the debt for the loan they make. A commonly used number is 1.25. This means that they want to see 25% more cash flow than is necessary to service the debt of the loan they make. Using this ratio, NOI could decline by as much as 25% and still generate enough income to service the debt. Using this ratio as a rule of thumb and applying it to the actual cash flow of a property will give you some idea of how much a lender will be willing to lend on a given property.

In conclusion, commercial lenders base their lending decisions primarily on cash flow from the property and not of the financial strength or creditworthiness of the borrower. Additionally, they apply safety measures including the establishment of reserve accounts and a DCR to assure that the cash flow from the property will be sufficient to service the debt.

By: Karen Hanover

About the Author:
Take a FREE Online Course! http://www.cieinst.com

Karen Hanover is well known as a Certified Commercial Real Estate Advisor, President of the National Apartment Investors Association, Chairman of the National Commercial Real Estate Advisory Board and Senior Instructor for both the Self Storage Education Institute and the Apartments Education Institute.

As a CCIM Candidate, a highly prestigious designation, often called the “Ph.D. of commercial real estate” Karen works as a busy commercial real estate agent with Marcus & Millichap one of the nation’s largest and most highly regarded commercial brokerage firms.

Sought by industry insiders for their toughest deals, Karen has helped thousands to create wealth in commercial real estate with less risk even in today’s uncertain economy.

Karen founded the Commercial Investment Education Institute which provides educational instruction for investors on multiple subjects including apartments, self storage, office buildings, retail centers, mobile home parks and more. Her courses are taught in a friendly and easy to understand manner.