How Commercial Mortgages are Underwritten

Commercial mortgages are underwritten differently than residential loans, hence the loan package needs to be assembled in a different fashion. When dealing with improved commercial real estate the property's net income is the most important factor in underwriting the loan.

Debt Service Ratio

The property's net income determines its ability to pay the monthly mortgage payment. This is commonly referred to as the debt service coverage ratio (DSCR) or the debt service ratio (DSR). For this reason a borrower's income is less important than the commercial property's net income. Some lenders will take into account the borrower's income and apply it as a global debt service coverage ratio.

Common Mistakes

Commercial mortgage brokers do themselves a disservice when they fail to acquaint themselves with the loan they are submitting. Often a mortgage broker will call saying that they have a construction loan on a piece of property. When the lender reviews the documents, they see that the loan is actually a development loan on a piece of raw land. This casts a bad light on the broker, lenders are busy people and see many deals in a day. If a lender is only making construction loans, yet they are submitted a development deal it is often a waste of their time. Broker's that don't understand the deals they submit are perceived as lazy, unintelligent, after a quick buck, or some combination of these elements.

Required Documents

Individual commercial lenders will give different weight to different elements of the loan package. It is best to assemble a complete package before submitting a loan to a lender. Knowing in advance what documents and information a lender will want is also helpful.

Executive Summary

Writing an executive summary is always helpful. A complete package may include hundreds of pages of data. It can be difficult to extrapolate the loan amount and the purpose of the loan from all that data. The executive summary should include a description of the property including square footage, number of units, location, and the lot size. The loan amount, property value, and purpose of the loan should also be stated. An income summary should also be included in the executive summary of the commercial loan.

Standard Documents

These documents should be included in all submitted packages:

• Loan Application
• Borrower's Financial Statements
• Borrower's Resume
• Borrower's Tax Return for 2 years
• Borrower's Credit Report
• Preliminary Title Report
• Property's Operating History for 2 Years
• Property's Rent Roll
• Property's Tax Return (if not included on borrower's)
• Purchase Contract (if a purchase money loan>
• Current Appraisal - Before paying for an appraisal you should determine if the lender only accepts appraisals from "approved" appraisers.

Other Documents

Construction loans, rehabilitation loans, acquisition and development loans may require additional documentation and you should be prepared to submit the following:

• Proforma Revenue Schedule - What will the income be after the repairs or development?
• Construction Cost Breakdown - How will the construction funds be used?
• Construction Costs-to-Date - Have funds been invested in the project and where did they go?
• Current Lender - Who are they? What is owed? Why won't they stay on?

Useful Information

When seeking commercial loan refinancing it is also useful to know:

• Current Loan Amount
• Original Purchase Price & Date
• Use of Additional Funds (if a cash-out refinance)
• Justification of Value - If the property value has increased dramatically, why is that? Better tenants? Capital improvements? Appreciation?

Summary

Commercial lenders want proof that they should make the loan. The property's income or future value should justify the loan amount requested. Commercial lenders are not allowed to make loans based on a broker's enthusiasm or the borrower's need for the loan. The numbers don't lie and often tell the true story of the loan. As Joe Friday says, "The facts ma'am, just the facts."