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Commercial property refers to one or more buildings, along with the land they occupy, that are used for profit-generating activities. This category includes apartment complexes with five or more units, office buildings, warehouses, storage facilities, and retail spaces such as convenience stores and shopping malls.
Qualification requirements for commercial loans can vary greatly from one lender to another. Reach out to us, and we’ll help you find the loan that best suits your unique needs.
Since your income may not be the main factor in qualifying for a commercial loan, it's important to understand how a commercial lender thinks.
While commercial lenders do review your credit and current income, their lending decisions are not primarily based on your FICO score or gross annual income. Instead, they focus on the cash flow generated by the commercial property. Typically, they look for the property's income to be at least 120% to 125% of the total operating expenses. This relationship is expressed as the Debt Service Coverage Ratio (DSCR). For instance, a lender may require a DSCR of 1.20 or 1.25, and different lenders may have varying DSCR requirements.
Lenders assess the value of a commercial property based on the net cash flow it generates, rather than what someone is willing to pay for it. For example, during a recession, if cash flow decreases, the property's value may also decline. To protect against this potential loss in value, commercial lenders typically set limits on the loan amount as a percentage of the property's current estimated value. This percentage is known as the Loan to Value (LTV) ratio, with 75% LTV being a common standard in commercial lending.
Commercial lenders determine a property's current value based on projections of its future net income. The Capitalization Rate, or "Cap Rate," is calculated by dividing the Annual Net Operating Income by the property's cost. By comparing Cap Rates of similar commercial properties, lenders can assess whether you're paying a fair price. Each lender may apply a different Cap Rate for various property types to establish an appropriate value range.
A non-recourse loan secured by a commercial property means the borrower is not personally liable for any deficiency if the loan defaults. In this case, the lender can repossess and sell the property, but if it sells for less than the outstanding debt, they cannot pursue the borrower for the remaining balance. Each lender has its own criteria for issuing non recourse loans, and typically, they may charge a slightly higher mortgage rate in exchange for this type of loan.
Commercial lenders don’t always adhere to strict, objective guidelines when making loan decisions. A Loan Committee has the authority to approve or deny funding based on various factors. Even if your financials are solid, a lender may still choose not to fund your loan, which could stem from their experiences with similar loans that have underperformed, rather than any issues with your application.