Commercial Loans

It's All About the Property

Getting familiar with Commercial Loans will be valuable to you if you decide you want to venture into buying apartment buildings (or multi-families as they're known in the biz).

In this type of financing, it will be all about the building, or asset, and not you. The main qualifier is the NOI, or Net Operating Income of a particular building.

The NOI for a property is the gross scheduled income (rents), plus any other income (i.e. parking or storage unit fees, laundry facilities, etc.) MINUS a vacancy allowance, and MINUS operating expenses (i.e. taxes, insurance, utilities, property management, etc.). This is your before Debt Service number, or in other words, how much the property makes before you pay the mortgage.

This is a very important number to the banks, since it indicates whether a property is making money or losing it. Qualifying can be much stricter than getting a residential loan. Normally, you will need to provide an Executive Summary outlining the pertinent information about the property, recent upgrades, area information, rental and possibly management history, reasons why the building is being sold, and so on.

Also, they will want to look at the Income Statement (Profit & Loss), the Rent Rolls (confirming which units are rented, for how much, when the lease expires, and the date of the last rental payment).

If all of this is satisfactory, then you can obtain financing, but sometimes you must put more money down or settle for a higher interest rate. It just depends on the lender and their particular philosophy at the time.

When buying commercial property, I take the NOI and multiply it by 10. If the price is equal to or less than that number, then I feel it is a good deal. If it is more, it still may work, but I'll probably have to do some serious review before making an offer.

In order to determine if a commercial property cash flows, simply take the NOI, subtract the mortgage payment, and whatever is left is your Cash Flow. Make sure you use the PITIMUMV Formula:

Principal

Interest

Taxes

Insurance

Management (8-10% of rents)

Utilities

Maintenance (5-10% depending on condition/age of building)

Vacancy (5-10% depending on area)

If you also use this formula, your calculations should be accurate. Remember, though, garbage in, garbage out. Besides looking at a P&L, I like to see some actual utility bills, insurance bills, etc., to verify the numbers.

Commercial loans can also be secured using creative financing methods discussed in the non conventional financing section, so don't feel like you must get a commercial loan through an institution. Remember, you always have options.