Over the years as a loan originator, I have received phone calls from individuals or realtors who are interested in obtaining loan proposals for apartments or commercial properties. The proposed loan could be used to refinance the property or for the properties that are going to be sold or exchanged.
Please understand that the information that you will be gathering, although somewhat laborious, is very important for lender's pre-review. This information will also be needed to proceed with the formal loan so all is not in vain.
If needed, be ready to explain the income stream. Break out the Gross Potential Income (as if 100% occupied) from other income such as security deposits, late fees, laundry income, etc. Some of the income you receive can be used for the loan and some may not be used. However your lender will need this information.
Be ready to explain any vacancy or rent loss and / or rental concessions that may be given to prospective tenants. If you are aware of the vacancy rate in your area, you may want to provide that information to your lender. Most lenders have a good idea where projects should operate, but you may know specific details that will help you and your lender.
Once you have the income / expense data, be ready to explain major variances:
A. Large changes in the income from year to year.
B. Large changes in expenses from year to year (such as capital improvements; roof replacements, exterior painting, etc.). One-time capital expenditures for roof replacements should be called a Reserve or Replacement item. The lender can deduct this amount from their analysis as it is not considered a yearly expense.
All lenders will require the above information as well as some photos of the project. Please understand that accurate information is very important especially during the initial stage of the loan evaluation process. The better the data, the better the loan quote.
Firm Commitment – A document that once signed by all parties is a contract or obligation
Conditional Commitment – Subject to certain requirements and unless all parties agree or comply with requirements (Example: Must not exceed 75% loan to value) the loan may never be funded.
Letter of Interest (LOI) or Loan Quote – A form that articulates the proposed term and condition of the loan, loan fees and cost associated to obtaining the loan (The strength of this document is minimal and is not binding to any party; it is just a reasonable expectation of the anticipated loan terms).
Loan to Value (LTV) – Most lenders quote a maximum loan that their specific company can provide. However, your property may not achieve that maximum.
Gross Potential Income Lender will determine the Gross Potential Income as if the property is 100% occupied.
Income from other Sources – Lenders will determine if there is any income from other sources that can also be used for the income stream.
Vacancy / Collection Loss – Lenders will determine the vacancy and collection loss of your project as compared to the market. In most cases, a minimum of 5% will be used regardless if your project operates at less than 5% for vacancy or collection.
Effective Gross Income – Gross Potential Income, plus other income, minus Vacancy / Collection loss.
Stabilized Expenses – Amount determined by your lender as stabilized over a long period of time.
Reserves for Replacement -An amount determined by the lender and used to establish Stabilized Operating Expenses. The amount covers roof, appliance, flooring, hot water units, air conditioning units, exterior of building etc., replacement. Example: The amount calculated estimates the cost to replace your roof, say $5,000, and you have a ten year life, therefore $500 per year will be allocated as an expense. Typically, total Reserves for Replacement for all categories can range from a low of $150 per unit per year to $250 per unit per year. Your lender will state their reserve replacement policy requirements.
Net Operating Income (NOI) – Effective Gross Income minus Stabilized Expenses and Reserves.
Debt Service Coverage Ratio (DSCR)- All income producing property loans are evaluated in the same manner. Example; lenders will indicate they require a 1.25 or a 1.00 Ratio of income to debt service (payment). The lender is saying that they will allow you to use 75% of your Net Operating Income to pay Debt. The term that should be used is "cushion factor or error" instead of DSCR. The lender does not want you to use all of your Net Income to pay on the loan. DSCR's will range from a low of 1:10:1 (90% of the Net Operating Income) to 1:35:1 (65% of the Net Operating Income) to make your loan payment. You must also find out the interest rate that they are using to apply in their calculations for your loan. Some lenders will use the start rate (if you are obtaining an Adjustable Rate Loan) for their calculation and other lenders will use a higher interest rate (other than your start rate) in their calculations. This will have an effect on the loan amount your property will qualify.
Underwriting – This is a combination of disciplines that a lender will employ to determine your loan qualifications. This Underwriter will take into consideration the purpose of the loan request, determine your creditworthiness, evaluate the value of the project, age, condition, etc., and Net Operating Income and mix them together to Underwrite your loan. Generally speaking, this person truly makes the decision of the loan amount you will receive.
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