In my previous blog we touched on the basic criteria that make a commercial mortgage loan a much different animal from a residential mortgage loan. In a nutshell, it is the fact that whatever loan amount is desired for an income producing property must be supported by the income that the given building produces. This leads us to the first most important calculation:
Net Operating Income
When you are speaking to a potential borrower, one of the first, if not the first thing that you will ask is (after or at the same time as credit score): Do you know what the net operating income of the building is? Simply, the net operating income, or NOI, is the gross rents of the building minus the operating expenses of the building. Because the NOI of the building has to be able to support the desired loan, it is imperative to get to a very accurate number. This means that we don't necessarily rely on what the borrower is telling us, but look for verification. This is important because any "inaccuracies" will come out during the due diligence process, so once again we do not want to waste our time on a deal that cannot be done. If actual expenses are higher than what we are being told, or actual rents are lower, this can turn what at first glance looked like a great deal into a deal that cannot be funded. A little legwork early in the process can save you a lot of time and effort later, as well as the experience of a deal "crapping out" late in the process.
What goes into the NOI calculation? We need the following:
Gross rents
Expenses
Property Taxes
Building insurance
Utilities
10% of the gross rents to account for management and vacancy
NOI = Gross rents - expenses
Very simple calculation. For verification of expenses, you can use PropertyShark.com for taxes or the assessor's office, and for utilities and insurance ask to see recent bills. As far as rents go, have an idea of what market rents in a given area should be, and ask for current leases. Once again, do not try and manipulate numbers to make a deal that won't work suddenly work. In this business your relationship with a lender is more important than a single deal, and trying to fudge numbers is the best way to lose that relationship. Realize as well, that everything will come out in the wash, or as we call it the due diligence process.
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