Who are wholesale commercial lenders?
The landscape for commercial mortgage lending continues to evolve. From stated-income to owner-user, high loan to value to negative debt-service-coverage ratio, today’s commercial loan programs accommodate more borrowers and more unique lending scenarios than ever before.
Wholesale commercial lenders are becoming more sophisticated and more demanding. Local banks, whose traditional loan structure boasted a three- to five-year term with a reset, are now challenged by an array of loan programs offered by an army of mortgage brokers in most U.S. markets.
While the landscape continues to widen, the fundamentals of commercial mortgage loan origination, underwriting and risk aversion remain consistent. There are some common, yet paramount techniques for originating commercial loans from the wholesale commercial lenders perspective. Following these steps will help you work better, not harder, and can increase your loan-closing ratio. The ultimate goal is to help your borrowers maximize the loan amount and to make it easy for lenders to do so.
Underwriting cash flows
Originating commercial mortgages begins with an understanding of what creates value in income-producing properties. wholesale commercial lenders concentrate primarily on the physical real estate — and specifically on the income it produces. Therefore, proper development and prudent analysis of an operating statement is paramount to underwriting.
The operating statement measures a property’s income and expenses. It includes the following information:
- Potential gross income: The potential income a property may generate at 100-percent occupancy (which includes potential income from vacant space at market rent) before expenses
- Effective gross income: The anticipated income a property may generate after adjustments for vacancy and collection loss and other adjustments including mark-to-market
- Net operating income: The anticipated income remaining after all operating expenses but before tenant-improvement costs, leasing commissions, capital expenditures, annual debt service and book depreciation
- Net cash flow: The anticipated income remaining after all operating expenses including tenant-improvement costs, leasing commissions and capital expenditures but before annual debt service and book depreciation
- Operating expense ratio: The magnitude relation of operating expenses to the effective gross income
Normalizing income and expenses
Operating statements vary considerably. Because of the disparate formats of operating statements, it is recommended that brokers reconstruct the borrower’s operating statement. You can do this by reconstructing a standardized operating statement from the borrower’s statement or property-tax return that includes a breakdown of all income and expenses specifically related to the real property.
It is important to collect and report income and expense information for at least one year, preferably the most recent full year, and to include a year-to-date statement. for wholesale commercial lenders, The potential gross income on the cash-flow analysis should match the one calculated from the rent roll. If it doesn’t, it must be reconciled.
An appropriate vacancy factor should be applied to the potential income to arrive at the estimated gross income. Move unusual and nonrecurring expenses (e.g., tenant-improvement and leasing-commission costs, replacement reserves, extraordinary capital expenditures, etc.) below the net-operating-income line. Adjust the expenses to compensate for expense inflation before calculating net cash flow.
Subtract the appropriate vacancy and collection loss from the potential gross income to arrive at the effective gross income. Then account for and normalize the property expenses — adjusted for inflation — and apply the appropriate underwriting fees and reserves to calculate net cash flow.
Wholesale commercial lenders estimate market value with the income-capitalization approach, which is NOI divided by the direct capitalization rate. The sales-comparison and cost approaches are developed to support the findings in the income approach. The cap rate is associated with the overall risk of the property — the lower the risk, the lower the cap rate. For scenarios where a market-driven cap rate is unknown, apply a standard cap rate based upon the property type, adjusted for the overall risk.
When normalizing operating statements, it is especially important to interrogate the items that are included in the repair and maintenance line. Repair and maintenance items include all recurring expenses necessary for general repairs and maintenance including common areas and building upkeep. These items are expended above the NOI line. Nonrecurring items, such as replacing a roof, heating, ventilation and air conditioning, plumbing or other major building systems, are expended below the NOI line. Expenses that appear above the line are normalized, and expenses below the line are not. This allocation can have a significant effect on underwritten NOI.
Calculating maximum loan amount
Generally, commercial mortgage loans are constrained by two calculations: 1. Maximum loan at maximum LTV; and 2. Maximum loan at minimum DSCR, where LTV and DSCR are inversely proportional.
LTV is calculated by dividing the requested business acquisition loan amount by the estimated property value. If the direct capitalized value is insufficient to cover the requested loan amount, the loan amount will be constrained by the LTV.
The DSCR is calculated by taking the net cash flow divided by the annual debt-service payments at the requested loan amount. If the net cash flow is insufficient to cover the requested loan at the target DSCR, then the loan amount will be constrained by the minimum DSCR.
Here’s how to calculate the maximum loan amount with each calculation:
- Maximum LTV approach: Apply an appropriate cap rate to the net cash flow to estimate the direct capitalized value. Apply the maximum LTV to the direct capitalized value to calculate the maximum loan at maximum LTV.
- Minimum DSCR approach: Divide the net cash flow (after reserves for TILC and capital expenditures) by the annual debt service, then constrain by the minimum DSCR.
Analyze the underwritten reserves and constraints to determine if the underwriting supports the loan request. Make adjustments to the underwriting based on the attributes of the property, the market and other considerations.
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