Commercial lenders have undergone a tremendous shift in how they assess risk due to the global pandemic, and you should know how these changes can affect your client’s ability to obtain financing. There are three major metrics that some lenders are weighing more heavily on, and these are:
- Debt Service Coverage Ratio (DSCR)
- Loan to Value Ratio (LTVR)
- Loan to Cost Ratio (LTCR)
Let’s take a dive into these more precisely.
DEBT SERVICE COVERAGE RATIO:
Net Operating Income (NOI) is the income produced from an investment property after deducting the real estate taxes, repairs, insurance, and any additional operating expenses, while the Debt Service is the annual mortgage payment on the property. Most lenders pre-Covid19 were stress testing loans at a minimum DSCR of 1.20x-1.25x, but during the pandemic, some of these same lenders have adjusted their risk levels to a minimum DSCR of 1.30x-1.35x. This change is a way for lenders to reduce their exposure on more risky loans, but may cause borrowers to reevaluate their lending needs.
LOAN TO VALUE RATIO:
Lenders rely on this ratio as a measure of risk involved with placing the loan. A higher leverage loan means the borrower has less equity invested in the commercial property and usually is viewed as a riskier loan. A lower leverage percentage means a lender views the loan placement as less risky with more borrower equity involved in the property. LTV is also a way for borrowers to determine how much equity is needed as a down payment in their acquisition of investment properties. In a pre-pandemic lending environment, borrowers were more inclined to have higher LTVs as lenders were more capable of providing these options. However, during the pandemic these same lenders have tightened LTV policies, requiring a larger down payment or preferring lower LTVs for refinances.
LOAN TO COST RATIO:
This ratio is presented as a percentage that expresses the overall equity investors have into a commercial project. A lower LTC means that the investor has more equity in the project, while a higher LTC ratio means less equity into the project. This ratio is used to help lenders determine the amount of funds they are willing to lend up to based on the total project cost, as it is different from the LTV ratio which is based on fair market value. Traditionally this ratio would not exceed 85%, but in a pandemic related environment, the LTC requirements have become more difficult and resulted in lowering the max LTC. This has proven to be challenging for investors who, acquire investment properties, rehab them, increase the NOI and request a cash-out refinance, because now the investors are potentially limited to the amount of capital they would pull from the completed project.
These ratios are critical for every investor to keep in mind because these changes can ultimately determine eligibility for commercial and apartment loans. That is why a trusted Commercial Mortgage Banker can help to navigate these uncharted waters and determine the best lending partners to utilize.