Learn some key terms and get introduced to the application process.
Last time in our Path to Commercial Real Estate Ownership series we covered not only how to evaluate a property, but also questions you can ask yourself to potentially expose personal priorities you may not be aware of. Often, investors jump in on an opportunity too quickly without a clear understanding of their goals, commitment level, and roadblocks that may impede progress. While the journey to ownership is a complex undertaking that can be challenging for even the experts to time correctly, it pays to do your homework and know your vocabulary. Let’s brush up on some key factors that will help qualify you for a commercial loan and prepare ourselves for the application and underwriting process.
Commercial Real Estate Qualifiers
While the approval process for a commercial real estate loan is significantly less stringent than traditional bank lenders, there are a few items lenders identify to rule out risky possibilities. In case you’re not familiar with the following terms, let’s review.
Debt Service Coverage Ratio (DSCR)
A borrower’s ability to repay the debt is the primary qualifier for commercial real estate bridge loans. This is most often measured by using the debt service coverage ratio (DSCR)—which calculates the annual net operating income (NOI) of the property. The NOI must be sufficient to cover at least the annual carrying costs of the financing. 100% coverage is expressed as 1.00, and lenders will typically require a ratio of 1.1 – 1.25.
Net Worth / Cash Reserve
Lenders evaluate the financial strength and determine the collective net worth of the individual or group applying by reviewing financial statements. Lenders may also require proof of cash reserves to cover certain contingencies. Lenders often hold back a certain amount of the loan proceeds as an interest rate reserve. This provides the lender a fund from which to draw monthly interest payments, while the property is in renovation status—and therefore not generating a profit.
Your credit score—while key in traditional types of financing—doesn’t play a significant role for commercial bridge loans. That said, most bridge loan providers will check your credit, and will expect a credit score above 650. Your DSCR and net worth far outweigh your credit score when bridge loan lenders are considering your application.
Next time, we’ll get into the loan request and outline exactly what you need to include and how to layout the documents.