Commercial vs. Residential Mortgages

There is one fundamental difference between commercial and residential mortgages. With commercial mortgages it is primarily the building and the cash flow it produces that qualifies the mortgage for funding not the borrower.

Commercial lenders originating long term commercial mortgages, as against short term hard money mortgages, are very concerned about the following:

  • What is the net operating income of the property (NOI)?
  • What is the debt service coverage? (DSC.)
  • What is the occupancy rate of the property?
  • How long are the leases?
  • Who are the tenants?
  • Lets look at each of these in turn.

Net Operating Income (NOI)

This is the income produced by the property excluding interest payments, capital repayments and depreciation.

Debt Service Coverage (DSC)

What is the ratio by which the NOI exceeds the Principal and Interest payment.
If the NOI is $130,000 per year and the P and I is $100,000 per year, the DSC is 1.3 (130,000/100,000).

Lenders look for a DSC usually around 1.25 but it could range from 1.00 to 1.40. The lower number can occur when there is a triple-net leased property to a very financially strong tenant, like a Walgreens, where 100% of the income goes to service the loan.

Occupancy Rate

Even if the property is 100% occupied, lenders will allow a notional vacancy factor of 5% or more. Some lenders refuse to lend on properties below a certain occupancy factor, like 70% for instance.

Lease Terms

The longer the leases, other things being equal, the more financiable is the property.

The Tenants

It doesn’t take a genius to figure out why Microsoft or Bank of America is a stronger and more “bankable” tenant than Joe’s Pizza Place.

For a quick and dirty calculation of the possible loan amount go our Online Calculators Commercial Real Estate Mortgage Qualifier.

Also, see our Commercial Loan Application sample form (Microsoft ®Word document).