Evaluating Commercial Real Estate Investments - Calculating DSCR and LTV

Hopefully you now have a good hanldle on cap rates, and we can move forward with analyzing that small retail property in downtown Reading, PA.  Once you have an idea about what a property is worth, you need to figure out how you are going to pay for it.  For most investors this means getting a mortgage.  So how do you know how large of a mortgage your property will qualify for?  Notice this is about what the property will qualify for, not you personally.  For commercial properties, the property itself is often more important than the borrower when qualifying for a mortgage.  The two primary tests that your lender will use to determine how large of a mortgage your property can manage are Debt Service Coverage Ratio (DSCR) and Loan To Value (LTV).

DSCR is exactly what it sounds like.  It is a test of how much debt your property can service, or how large of a payment will your NOI cover comfortably.  Each lender will different criteria, but we'll use a DSCR of 1.25 for our downtown Reading, PA retail property example.  So the calculation looks like this:

So using this equation, the retail property in our example could support a maximum monthly payment of $1,306.53.  At this point I usually use Microsoft Excel, but you can also use a mortgage calculator.  Again we have to make some assumptions about the length of time we can ammortize the loan over, and about the interest rate.  My inputs in Excel are below:

So using the DSCR the maximum loan amount is $175,238.34, but we still need to look at the LTV.  This calculation is much easier.  You simply multiply the maximum LTV by the value of the property.  It's important to note that most lenders will use the lesser of value or purchase price.  For our example, we'll say that our lender has a maximum LTV of 70% for retail properties in Reading, PA.  LTV limits will often vary by lender, by propery type, and by market.  So let's assume we're buying this retail property for $195,980, which happens to be what we calculated the value to be in my earlier post.  By multiplying this number by 0.70, we arrive at a maximum loan amount of $137,186.  Most lenders will use the lower of the two numbers calculated using the DSCR and LTV, so in this example, the most we can borrower against our retail property in Reading, PA is $137,186.

We're almost ready to decide if we should invest in the retail property in Reading, PA.  Next time start to look at our projected return on investment.  In the mean time, if you are interested in investing in commercial real estate in Reading, PA, give me a call and we'll go through the numbers together.