Module 4.1 The Real Estate Market Flashcards
What is the difference between commercial and residential mortgages
intended to be used or refinanced by some other than the owner.
List of differences between commercial and residential mortgages
different kind of property more limited transaction types different focus for qualifying different qualifying guidelines and ratios different kind of applicant different relationship with applicants deals tend to be unique increased level of deal complexity longer time to closing different interest rates, fees, and closing costs different mortgagee compensation in the form of participation, for example, the following: percentage of sales percentage of net profit percentage of capital gain percentage of increased rental income
What is a commercial mortgage
- a mortgage loan made using commercial (income generating) property as the loan security. Often secured by real property, however not lived in by an individual, and secured by things like stores, apartment block, office, or other types of income generating companies.
what are the three types of commercial properties
Industrial
commercial
Investment
what is an industrial mortgage -
properties for the intended use of manufacturing and production owners/tenants. (Agricultural land is often seen as a distinct real estate class, but it is industrial “production” until planned for commercial or investment use.)
what is a commercial mortgage
properties for the intended use of sales and service owners/tenants, such as retail sales and warehouse space, offices, and service bays
what is an investment mortgage
properties for the intended use of residential development and multi-unit rentals.
examples of commercial properties
vacant land zoned for commercial development (serviced or unserviced)
multi-family accommodation properties - apartment buildings, multiplex residential units, hotels, motels, guest houses, etc.
office buildings
retail properties – shops, stores, malls, gas stations, etc.
leisure industry properties – resorts, spas, sports and recreation centres, campgrounds, golf courses, pubs, restaurants, fast-food outlets, etc.
industrial properties – warehouses, storage facilities, distribution centres, manufacturing facilities, etc.
healthcare properties – hospitals, nursing homes, medical centres, etc.
other property categorized as commercial under local land-use bylaws
what things might a commercial refinancing transaction involve
expanding or renovating a business property
buying out a partner’s share of a business property
accommodating a tenant’s purchase option in a business property debt consolidation
leveraging a commercial property for tax and estate planning
main difference between a commercial mortgage brokerage and residential brokerage
- focus for qualifying.
- residential –both the applicant and property must qualify, but the applicant is the primary focus.
For commercial –
both the applicant and the property must qualify, however the property is now the main focus.
- properties ability to generate income, and confirmed through leases, other forms of cash flow and resale value.
what are underwriting guidelines for commercial mortgages
- mainly structured around property valuation, cash flow, and the ability of the property to generate income.
what are the qualifying ratios for commercial mortgages
- Normally LTV and debt service coverage ratio (DSCR)
What is DSCR ratio and what does it stand for
debt service coverage ratio and
ratio of cash available for debt servicing to interest, principal, and lease payments:
Essentially ranks the persons ability to produce enough cash to cover its debt (including lease).
what is the typical loan size and repayment plan for commercial mortgages
- typically larger than residential, ranging for 10,000 to billions
- typically repaid through set monthly payments
different ways a commercial applicant may be set up
- Sole Proprietorship
- Partnership
- Corporation
- limited liability company
- limited liability partnerships
what is a corporation
A company that has been incorporated. Corporations are legal entities, recognized under law as an individual. The people running a corporation are typically not liable for debts incurred by the corporation. The personal assets of those running the corporation are severed from the portfolio of the business.
what is a limited liability company
Similar to corporations in that owners, directors, and/or stakeholders are protected from having their personal assets accessed to meet the company’s debt obligations. Income flows through owners/investors (and is taxed accordingly) in a manner more like sole proprietorships or partnerships than like corporations.
What is a limited partnership
This type of partnership is very common when people are putting together an investment in a real estate development. A limited partnership requires a written agreement between the business management who is (are) general partner(s) and all of the limited partners. Each limited partner makes an investment of funds into the partnership and is supposed to receive a pre-stated share of the profit, which is ordinarily greater than that of each of the general partners up to a point (such as return of the investment), and, thereafter, the limited partners will receive a lesser share than the general partner(s). Quite often there is also a provision for eventual buyout of the limited partners by the general partner(s). The limited partners may not participate in the management decisions of the partnership, or they will lose their limited partnership status.
what type of business does a lender prefer to lend to
- normally corps, and may require an applicant be incorporated.
- usually a company that purchases or refinances a property.
what do lenders look for, for borrower competency for commercial mortgages
applicants ability to manage and sustain the income or the sale projections of the commercial property.
history of real estate/property management/sales and the business succession plans may be a strong component of the lenders decisions.
example at what a lender will look at for lending commercial loans
Another example, related to succession plans, is a local developer completing a subdivision. The commercial underwriter will look at the marketing plan and absorption assumptions, but ask the following questions: is the principal owner or a staff member a “key man” in keeping the project on track? What would happen if the “key man” became sick got injured or died? Who will be his or her successor to complete the project? Could the risk be mitigated by the taking out of “key man” insurance that is lender owned and benefits the lender directly, if such an event happens?
what are reasons the lender prefers to work with corps and not sole prop for commercial mortgages
gives them the option to request additional security and/or the personal guarantees of the principal(s) of the corporation or company. A personal guarantee is a promise made by a business owner that obligates him or her to honour the debts incurred by the business. The size of the personal guarantee is determined by the lender and can be any amount up to and including the full value of the mortgage loan amount.
When a lender has a personal guarantee, the lender can pursue the personal assets of the owner if he or she defaults on the loan and the business assets are insufficient. Whether a lender asks for a personal guarantee or not depends on factors such as the strength of the application and the size of the company. Large companies with many shareholders would not likely be asked to provide personal guarantees.
why do commercial deals tend to be unique and complex
- most have little in common because each is so varied
- more complicated comparred to residential. amount and type of paperwork is more complex and more time consuming to obtain and review. permit delays, environment issues and even partner disputes can cause deals to fall apart.
- essential to submit strong notes and ensure complete documentation is provided to achieve a high close ratio. if a broker has a low ratio they should speak with lenders to see why (often related to not providing needed documents or level of detail required for a commercial transaction.
why does it take longer to process a commercial application
- most additional conditions take more time to address
- Commercial property appraisals are almost always required, and because of the increased depth and scope for a commercial property appraisal, it can take a month or more to arrange and complete.
Environmental studies can also take a month or more to arrange and complete. A Phase I Environmental involves a map review and site review by the engineer. It is not unusual for the Engineer to recommend a Phase II (bore testing) because gas stations or dry cleaners are, or have been, within artisan corridors (an area dedicated to businesses and vendors who are involved in the arts community).
Due diligence involves assessing the income-generating potential of a property and this requires detailed review of financial statements, revenue forecasts, budgets, leases etc.
How is the rates, fees, and closing costs determined for commercial mortgages
- rates are typically not posted because the transactions vary so widely from deal to deal.
- decision for rates is reviewed on case by case basis and rated as per the assessed risk.
- Rates are normally 180 to 220 bps above Canada Bond rates
what brokerage fees(compensation) are normally charged for commercial deals
- almost always brokerages charge a brokerage fee. fees can be significantly higher than residential.
Ex - 1% finders fee on commercial mortgages for a two million dollar property is 20,000.
why are closing costs for commercial mortgages higher
- often involve real property appraisals, environmental studies, brokerage fees, ect..
- all are elevated prices, ex - may pay 3500 for appraisal instead of 400
meaning of land use code C-N1
- Commercial neighbourhood
- small storefront retail businesses in community. caters to local pedestrian traffic. little or no addtional parking. close to sidewalks. primarily services to immediate local neighbourhood
meaning of land use code C-N2
- Commercial neighbourhood
- Smaller retail businesses and services. Caters to automobile traffic and pedestrian traffic. Parking lots available. Situated adjacent to residential properties (no setback from street). Business size restrictions to ensure compatibility with community and minimize negative impacts on residential areas. Primarily serves the local community.
Meaning of land use code C-C1
- commercial community
- Small- to medium-sized businesses. Set apart from residential properties through landscaped areas and/or setback from street to minimize negative impact on residential areas. Caters to automobile and pedestrian traffic. Primarily serves a number of communities.
- grocery stores
Meaning of land use code C-C2
- Commercial community
- Medium-sized businesses. Multi-property retail complexes. Situated on boundaries of communities. Larger parking facilities shared among building tenants. More landscaping and setback. Larger commercial use area.
- Multi-tenant retail and service plazas and complexes (but not big-box retail)
Meaning of land use code C-COR1
- Commercial corridor
- Small storefront businesses on both sides of the street. Caters to pedestrian traffic. Little or no parking facilities apart from street parking. Buildings close to sidewalk. Typically found in historic or revitalized neighbourhoods.
- shopping districts in historic neighbourhoods
Meaning of land use code C-COR2
- Commercial Corridor
- Small- to medium-sized businesses situated on commuter routes or on the boundaries of high pedestrian traffic areas.
- Multi-tenant retail and service plazas and complexes (but not big-box retail)
Meaning of land use code C-COR3
- Commercial Corridor
- Small- to medium-sized businesses situated on high-traffic roads. Caters to automobile traffic. Buildings set back from street and have own entryways (access), parking, and landscaping.
- Multi-tenant retail and service plazas and complexes (but not big-box retail)
Meaning of land use code C-0
- Commercial office
- Sites purposed for office space. Some retail businesses and services that support the population in the office spaces.
- Office buildings and business complexes
Meaning of land use code C-R1
- Commercial residential
- Large-scale retail operations. Typically single-use site. Caters to automobile traffic. Situated on major thoroughfares.
- big box retail
Meaning of C-R2
- Commercial residential
- Large-scale retail operations. Multi-tenant buildings. Situated on major thoroughfares, accessible by public transit. Caters to automobile traffic and public transit traffic. Building centered on site with parking surrounding building.
- large shopping malls
Meaning of land use code C-R3
- Commercial residential
- Large-scale retail, dining, and entertainment developments. Allows a variety of building sizes and uses. Requires a large area of land.
- large shopping malls, entertainment complexes
what is a development permit in relation to commercial mortgages
is a document that is issued under a land-use bylaw to authorize a development. The permit may be approved or refused. If refused, the development authority is obligated to provide reasons for the refusal. If approved, the development authority may place conditions on the approval.
Common lender considerations about commercial properties
- Physical condition
- Location
- type, demand for, and viability of the business
what do lenders consider in regards to physical condition of commercial properties
- condition directly impacts revenue generating potential and resale. Ex - age, structurally sound, deferred maintenance and the remaining life span
what are lender considerations for location in commercial mortgages
- curb appeal
- availability for parking.
- for manufacturing or industrial they may take location as near appropriate transportation for receiving raw materials and delivering finished goods
what is LTV for commercial as compared to residential
- LTV ratios are lower for commercial. commercial lenders normally do not have security as protection of mortgage defualt insurance.
- normally require borrower to have higher equity
is mortgage default insurance available for commercial LTVs
Yes but not always. normally for particular types of commercial propertys.
- lenders may be more willing to finance if MDI is used.
- may have for multi-fmily properties, but fees are normally higher.
what is a mixed use property
- one that has two or more functions.
- building with retail stores on the main level and apartments above.
what are 4 lending sources for mixed-use properties
- chartered banks
- credit unions
- trust companies
- private lenders
what is a multi-unit residential property
Apartment buildings are the most common example of a commercial multi-unit residential property, but this category might also include student housing complexes, senior’s housing, low-rises, high-rises, military housing, co-op housing, or any building with more than four units.
how many units of multi-unit can be serviced under residential mortgages
normally four or less units
what are lenders risk factors with multi-unit
- risk is generally low as there is always a demand for rental housing. normally easier to rent.
property grading for office buildings
- brokers normally grade as followed
A grade office space - might include parking, retail potential, and amenities such as food outlets on - site or nearby
B grade office space - offer amenties but no parking or street parking.
C grade office space - less and less amenities, and or/convienances.
what is anchored versus unanchored retail properties
Retail properties may be anchored (where a large, well-known tenant such as a department store or large supermarket draws consumers into the shopping centre) or unanchored (like a smaller strip mall or shopping plaza).
what are interest rates for anchored properties
- properties that have a largem nationally branded anchor tenant are more stable in terms of income stream. lenders will offer the best rates for these.
- as brand recognition decreases, the rates will increase.
some lenders for small businesses
- can include business development bank of canada, and the government of canada small business financing program
two potential lender concerns for risk in industrial complexes
limited use in the even of a foreclosure, and environmental issues such as ground contamination.
LTVs normally accepted for industrial properties
Chartered banks normally accept 65%. may be higher if owner occupied
what are some special use properties
- car dealerships
- churches
- gas stations
- nursing homes
- hospitals ect…
risk factors for special use properties
- lenders normally reluctant to finance places like churches. appearance and structure limits the resale and flexibility to use as another purpose.
- political issues as well (noone wants to foreclose on a church)
What two types of lenders are there for commerical mortgages
Institutional and private
Types of institutional lenders for commercial mortgages
chartered banks, credit unions, and trust companies (referred to as prime lenders in the context of residential mortgages; operate in the primary mortgage market)
conduit lenders (operate in/ funding from the secondary mortgage market)
pension funds and insurance companies (operate in / funding from the secondary mortgage market)
Business Development Bank of Canada (BDC) and small business development programs (funding from government sources)
what kinds of clients do institutional lenders take
The applicant has a significant amount of equity (down payment)
It is a priority to minimize the costs of borrowing (lower closing costs, fees, and interest rates)
The applicant does not require bridge financing, quick closing, has zoning and permits in place, etc. In other words, the applicant does not require a great deal of flexibility
The subject property is considered a high-quality, low-risk investment. In other words, it produces a stable, reliable income stream and is readily marketable
how stringent are Institutional lenders on making commercial loans
normally because they are more complicated, the lenders prefer to prep for applicants underwriting and thus commercial lending is not prefered
where do conduit lenders get their money from
secondary mortgage market from selling commercial mortgage-backed securities and from large institutional investors
How do conduit lenders differ from banks
Conduit lenders differ from banks in that they are not lending their “own” money. They service and administer commercial mortgages, but often collect interest payments on behalf of their investors. Conduit lenders originate commercial mortgages with the intention of securitizing and trading them as CMBS. They are, in essence, “middle men” between commercial applicants and the investors who are the source of the mortgage money.
what are some pros and cons to working with conduit lenders
- major source of large, term commercial loans
- lowest fixed rates on commercial mortgages
Cons
- have stricter property condition and term requirements because they need to securitze
What are the payout penalties for conduit lenders
- normally heavily penalized IOT ensure investors receive expected yields
Preferred projects and quals for pension funds and insurance companies
- prefer to finance large office buildings, shopping centres, large scale apartment buildings, other commercial mortgages in 5M to 100M
what is the BDC and how does it fund small businesses
The Business Development Bank of Canada (BDC) is a Crown corporation with a mandate to provide funds for commercial and/or industrial development and sometimes farming. The BDC can offer longer terms, personal asset exclusions, no-penalty prepayment options and other features that are less rigid than those offered by other commercial lenders.
what is BDC LTV
- normally does higher LTV and longer fixed-term rates
what is the key features for BDC
loans are insured, that way if defaults, the banks receive all or a portion of its money back
how to commercial private lenders operate
- essentially the same a residential
- offer 6 to 18 months terms and can offer quicker turnaround times, and may charge more interest
what is commercial private lenders main advantage
- offer more flexibility and speed
what kind of commercial mortgage business do private lenders accept
The applicant has a high percentage of equity in the property (for example greater than 25%)
The applicant is willing to accept a higher cost of borrowing (higher interest rates) in order to obtain maximum mortgage amounts or for other reasons to obtain the financing
The applicant requires bridge financing, a quick close to the transaction, some latitude to obtain permits or land-use authorization, or some other consideration that requires flexibility
The applicant is financing a property that exhibits less than ideal cash flow or marketability.
what kinds of commercial mortgage business do private lenders accept
The applicant has a high percentage of equity in the property (for example greater than 25%)
The applicant is willing to accept a higher cost of borrowing (higher interest rates) in order to obtain maximum mortgage amounts or for other reasons to obtain the financing
The applicant requires bridge financing, a quick close to the transaction, some latitude to obtain permits or land-use authorization, or some other consideration that requires flexibility
The applicant is financing a property that exhibits less than ideal cash flow or marketability.
what are qualification requiements for CMHC for commercial mortgages
CMHC offers multi-family, multi-unit (five or more) mortgage default insurance that can apply to new or existing student residences, retirement facilities, care facilities, condo construction, etc.
To qualify, the applicant’s net worth must be at least $100,000, and at least 25% of the loan amount. Corporate applicants require additional guarantees.
Other details include the following:
LTV up to 85%
premiums range from 4.5% for LTV=85%, to 1.75% for LTV=65%
fees can be variable based on factors such as number of units but an average application fee would be approximately $150 per unit
amortization of up to 40 years, with premium surcharges after 25 years
Documents to get for a commercial mortgage application
the principals of the corporation
proposed project outlines
a detailed outline of how the funds will be used
estimated market values for the business and the subject property
details of any additional collateral that may support the mortgage request
Other typical requirements
Some typical documents required for commercial loan requests include the following:
application documents such as the application form and service agreements
compliance documents such as consent forms and disclosure documents
property documents such as appraisal reports, property information and environmental assessments
cash flow documents such as rent rolls, leases and financial statements
applicant information documents such as credit reports, financial statements and net worth statements
how to craft detailed profile of the business
it is required to provide detail on the following:
the business (the applicant) and its management
identity and credit information for the business owner(s) or key management personnel
credit and income information for the business
information about down payment
detailed information about the subject property, especially with regard to it income-generating capacity
What key questions to ask when examining business and its management
- experiance
- operations
- advisors
- joint ventures
- financial
- additional security
- proposed purchase of project
explain experiance
The company’s (and/or management team’s) experience in operating income properties, and information about any other properties owned or being developed by the business
explain operations
Information about the company’s general operations
explain advisors
A list of the company’s professional advisors (accountant, auditor, lawyer, banking references, etc.)
explain joint ventures
Information about any corporate joint ventures, or other agreements or activities that may affect corporate decision making
explain financial
Business plans, cash flow statements, projected project budgets, and other financial statements
explain additional security
Information about if and what other security may be available in case of a default
explain proposed purchase of project
Detailed information about the project, such as survey certificates, environmental reports, structural engineering reports, compliance certificates, etc.
how to verify identity for a incorp business
certified copy of the Articles of Incorporation
certified copy of the corporate bylaws
a Borrowing Resolution of the Board of Directors
documents to gather for corporate credit history
financial statements
income statements
balance sheets
budgets
what is an executive summary to obtain a letter of interest
The purpose of creating an executive summary is to find a lender who is willing to consider the transaction. This willingness is indicated through a letter of interest (also called a letter of intent, a discussion paper, or a terms sheet). A letter of interest is not a commitment to lend, but rather an expression of interest to proceed with further underwriting
how to prepare an executive summary document
The summary usually includes a brief description of the borrower, property, financing being requested, highlights of the NOI (net operating income) and DSCR (debt service coverage ratio) or financial statements, lending area, etc.
NOI is rental income of a property after operating expenses. These expenses would include all operating expenses, including maintenance, janitorial, supplies, insurance, accounting, management, etc. NOI will be discussed, and the calculation shown, later in this module.
NOTE: It can take some time (10 to 30 days or more) to find a commercial lender who will provide a letter of interest, so be sure that your applicant is aware that it can be a lengthy process.
what kind of appraisal is mostly used for commercial mortgages
Income Capitalization Approach (income approach)
what are the two main assumptions for income apprach appraisal for commercial mortgage
The value of a property is directly related to the income it will generate.
A buyer/investor will pay more for a property that earns (or will potentially earn) more than a comparable property.
what are the two main assumptions for income approach appraisals for commercial mortgages
The value of a property is directly related to the income it will generate.
A buyer/investor will pay more for a property that earns (or will potentially earn) more than a comparable property.
what is net operating income
The gross income generated by the property, less vacancies, expenses, and overhead costs, results in a net operating income. This figure is used by appraisers as a measure of the subject property’s ROI when they determine value using the income capitalization approach.
what is roi
Return on investments which is calculated using the gross revenue minus any costs
General process for income approach valuation for commercial mortgages
Determine the stabilized, annual net operating income for the property.
Determine an estimate of overall property value by capitalizing the net income.
How to determine the annual, stabilized, net operating income of a commercial building
determining the potential gross annual income from all sources
deducting annual operating expenses (for example, maintenance costs and management fees)
deducting an allowance for vacancies and bad debts
Explain potential gross annual income from all sources
is a revenue estimate based on current market rents in similar properties. Potential gross income refers to a 100% occupancy situation.
Other income that may be added into the potential gross annual income estimate includes parking rentals and income from laundry facilities or other areas associated with the subject property that generates income.
explain annual operating expenses
you must first determine which expenses are considered operating expenses and which are not. Only those operating expenses that are payable by the landlord are included in the calculation of NOI.
List of operating expenses
- property taxes
- fuel (avg of 3 years)
- utilities (avged over 2 to 3 years)
- Maintenance and repair
- Reserve/replacement fund contributions
- Management fees and/or salaries of on-site personnel
- Property insurance
- Miscellaneous expenses
Explain what fuel for operating costs
The cost of oil, gas, electricity, or coal to operate the heating system
Can be estimated from three years of previous fuel receipts
Explain Utilities
Sometimes landlord pays all utilities; other times tenants are responsible for their share. Many buildings are not equipped to measure each unit for utility consumption.
Landlord’s portion typically includes utilities for common areas, swimming pools, exterior lighting, laundry equipment, ventilation systems, etc.
Can be estimated by averaging two to three years of previous utilities bills/statements
Explain Maintenance anf repair
Maintenance includes cyclical items such as interior/exterior painting, decorating, cleaning (common areas), inspections, etc. Interior painting, for example, is considered necessary every three years. This maintenance expense item would be divided by three and stated in the budget as an annual expense item.
Long-term tenants are typically responsible for tenant improvements
Repair includes service and replacement of structure and structural systems such as the ventilation, heating, air conditioning systems, elevators, etc.
Can be estimated from service agreements with system contractors (elevator contractor, furnace contractor, etc.)
Explain Reserve/replacement fund contributions
Contributions into reserve fund for replacement or major repairs are allocated as an expense
Replacement of short-life equipment such as appliances typically becomes necessary every seven years
Flooring in high-traffic or common areas can be maintained for up to 10 years before replacement becomes necessary
explain Management fees and/or salaries of on-site personnel
Fees for management services such as rent collection, payment of operating expenses, increasing/maintaining occupancy and supervision of building operations
Owners who perform some/any of these tasks can estimate a suitable fee, which is then allocated as an expense
Also includes salaries, benefits, unemployment insurance, pension plan contributions, and other employee expenses for on-site caretakers, gardeners, cleaning staff, etc., not associated with a management company
Can be estimated from employment contracts and provincial employment standards
Explain Property insurance
Includes the cost of replacement due to fire loss; repair or rent lost due to vandalism, sewage back-up, or other insurable property damage; and public liability
Can be estimated from insurance quotes or actual past insurance fees
explain misc expenses
Includes minor operational expenses such as supplies, advertising, licensing and permits, cleaning fees, etc.
Can be estimated from lease terms. Appraisers review lease terms for distribution of miscellaneous expenses between landlord and tenant(s)
what is not considered an operating expense
personal property such as lawn mowers, tools, etc. mortgage interest income taxes capital gains taxes brokerage fees
what operating expenses are included in ROI
only those operating expenses that are payable by the landlord are included in the calculation of NOI.
what is an escalator clause
where if a particular expense increases over a certain amount, the landlord can require the tenant to pay a portion. For example, an escalator clause may state: “Tenant is responsible for 50% of portion of increase in management fees over $10,000.” In other words, if management fees increase, the tenant must split the amount of the increase with the landlord (each paying half).
determining an allowance for vacancies and bad debts
Vacancies and bad debts are deduction allowances that are a percentage of the potential gross income, which may or may not reflect the number of vacant suites. They are based on long-term vacancy trends in the given area. These allowances are subtracted immediately from potential gross income and are NOT considered expenses.
- Leases as they confirm vacancies, and maturity dates of leases
determining net operating income
plus (+)
Other income
(Parking rentals, income from laundry facilities, signage etc.)
minus (-)
Vacancies and bad debts
(Percentage of gross potential revenue based on long-term vacancy trends in a given area)
equals (=)
Effective gross income
(The potential gross income with allowances for unrented suites or unpaid rents; that is, the income “realized” from occupied suites)
minus (-)
Operating expenses (landlord) (Only those operating expenses payable by the landlord)
equals (=)
Net operating income (NOI) or net operating loss (NOL)
Does a vacant building make operating income
A vacant building has no net operating income: There is no income stream if there are no tenants paying rent. A vacant building does, however, have income-generating potential when considered over a period of time as leased at typical market rates and occupancy levels. This is known as stabilizing the NOI.
How to calculate NOI
The ZZZ Building is a strip mall with four retail storefront units. It recently underwent renovations to update the design and décor, and is currently completely vacant. The current rental rate for similar units is $5,000/unit/month. Occupancy rates for similar types of strip malls over the last three years average 95%, which translates to an average vacancy rate of 5%.
To calculate the NOI, Mortgage Associate Jones must determine the potential gross annual income, the vacancy allowance, and the effective gross annual income.
Potential gross income: 4 units x ($5,000 x 12) = $240,000
5% vacancy rate: $240,000 x 0.05 = $12,000
Effective gross income = Potential gross income – Vacancy allowance
= $240,000 – $12,000
= $228,000
This figure for effective gross annual income would then be used to calculate a stabilized NOI.
How to determine property value by capitalizing the net operating income
find capitalization rate and apply that rate to the net operating income.
Net annual income (I) ÷ Capitalization rate (R) = Property value (V)
what is IRV
The combination of net operating income, capitalization rate, and the value of the subject property
How to manipulate the IRV formula
Value = Income ÷ Rate Income = Value x Rate Rate = Income ÷ Value
how is capitalization rate determined
using sales data from the same market. You can estimate from previous, similar transactions, using existing market data
example of finding capitalization rate
For example, assume that a small apartment building has sold for $950,000. It has eight units, each of which rents for $1,500/month. Also assume that the operating expenses for the building are equal to 20% of the gross annual income. The capitalization rate is determined as follows:
Capitalization rate = Net annual income ÷ Sale price
R = I ÷ V
First determine the net annual income using the data provided above:
Net annual income = Gross annual income – Expenses
= 8 units x ($1,500 x 12) –Expenses
= 8 units x $18,000 – Expenses
= $144,000 – Expenses
= $144,000 – 20%
= $144,000 – $28,800
= $115,200
Next, input the known values into the capitalization rate formula:
Capitalization rate = Net annual income / Sale price
= $115,200 / $950,000
= 0.121 or 12.1%
For this example, the capitalization rate is 12.1%. To determine an estimate of market value for the property, you would next apply the capitalization rate to the net operating income.
From an investor point of view, what is capitalization rate
the time it takes the investment takes to pay for itself
Ex - if a property is sold for 1 million and generates 100 k of annual net income then the cap rate would be 10%
how to calculate debt servicing ratio (DSCR)
DSCR = Net operating income ÷ Total debt service
Meaning of DSCR
DSCR < 1.0
Negative cash flow at this level of financing; the property does not generate sufficient income or cash flow to support the loan payments
DSCR = 1.0
Break-even point; the property only generates enough income or cash flow to meet the mortgage payments; most lenders would consider this to be unacceptable
DSCR > 1.0
The cash flow or income from the property covers the mortgage payments by 1.x; commercial lenders vary in terms of what “x” must be, but many consider 1.2 to be a minimum acceptable DSCR.
three requirements for documents
complete and accurate
properly stored to protect against improper access to client’s personal information
retained for the prescribed amount of time (as an associate, this means until you turn them over to your broker; at the brokerage level much longer)
Another name for a letter of interest
Executive summary
Main criteria for underwriting guidelines on commercial mortgages
- Property Valuation
- Cash flow
- property income generation
primary criteria for commercial underwriters
Resale value
What is the loan security for a commercial mortgage loan
A commercial income generating property
