Commercial Loans Blog

Operating Expense Ratio I

Posted by George Blackburne on Mon, Mar 26, 2012

The Operating Expense Ratio is used by commercial mortgage underwriters to catch commercial borrowers who are trying to cheat.  The Operating Expense Ratio is defined as the Projected Operating Expenses divided by the Effective Gross Income (the Gross Income minus a 5% Reserve for Vacancy & Collection Loss), the result multiplied by 100%.

Operating Expense Ratio = (Projected Operating Expenses / Effective Gross Income) x 100%

 

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Example:  Suppose an apartment building owner is trying to refinance his 64-unit project.  His Projected Operating Expenses for next year, including a 6% off-site property management factor*, is $248,064 per year.  His Projected Gross Income is $1,000 per unit per month, or $64,000 per month.  Assuming a 5% Reserve for Vacancy and Collection Loss, his Effective Gross Income per month is $60,800 (95% of $64,000).  If we anualize that number, we get $729,600.  Therefore:

Operating Expense Ratio = (Operating Expenses / Effective Gross Income) x 100%

Operating Expense Ratio = ($248,064 / $729,600) x 100%

Operating Expense Ratio = 34.0%

*  Even if he manages the property himself, the owner has to figure in the cost of an outside management comapany because if the bank forecloses, the bank certainly isn't going to manage the property itself.

If this ratio is too low, according to industry standards, the commercial lender will simply disregard the projected operating expenses provided by the borrower or broker and use an assumption instead.  This assumption is usually punitive and often kills the deal.

When most commercial mortgage borrowers apply for a new commercial loan, the single most important term in their minds is the loan amount.  Most commercial mortgage borrowers want the largest commercial loan possible.  If a commercial mortgage borrower is buying a property for, say, $1,000,000; he'll usually want to be able to borrow at least $750,000.  This way he only has to put down $250,000 (25% of the $1MM purchase price).

In real life, most commercial mortgage borrowers will choose a $750,000 loan at 5.75% over a $690,000 loan at just 5.0%.  It's the loan size, not the interest rate, that is usually the most important commercial loan term.

The problem, however, is that the commercial loan size is limited by the debt service coverage ratio.  You'll recall that the debt service coverage ratio is defined as the net operating income (NOI) divided by the debt service (annual principal and interest payments on the proposed loan).     Most commercial lenders today require a debt service coverage ratio of at least 1.25.

The higher the NOI, the larger the commercial loan for which the borrower can qualify, given a particular debt service coverage ratio.

Borrowers and brokers therefore have a large incentive to make the projected expenses on their operating statements look as low as possible.  After all, the lower the projected expenses, the higher the NOI appears.  The higher the NOI appears, the larger the commercial loan for which the borrower can qualify.

Commercial lenders therefore must be very suspicious of the projected operating expenses provided by either the borrower or mortgage broker.  The projected operating expenses are often understated or fudged.

So how can a commercial lender check to see if the projected operating expenses are reasonable or understated?  Commercial lenders use the Operating Expense Ratio to check to see if the projected operating expenses are reasonable.

So what are these industry standards for the Operating Expense Ratio?  We will cover them in our next blog article, Operating Expense Ratio II - What Ratios Will Commercial Lenders Believe.

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Topics: operating expense ratio

Marketing for Commercial Real Estate Loans - $199

Posted by George Blackburne on Wed, Mar 14, 2012

Imagine coming in to work at your commercial mortgage brokerage practice and finding four or five new commercial loan applications in your email box.  Imagine getting another dozen commercial loan leads calls over the course of the day.  Imagine having a magic button that you can push whenever your volume of commercial loan lead calls starts to fall off.  All of this is possible... if you know how to properly market for commercial real estate loans.

But marketing for commercial real estate loans can be very unrewarding, unless you know precisely what to do.  If you need commercial loan leads, you can easily waste tens of thousands of dollars and years out of your life on commercial loan marketing schemes that are a complete bust.  Imagine spending $10,000 on a large snail-mail campaign to commercial property owners and then not closing a single commercial loan.  Imagine paying $5,000 for a large magazine ad and then not getting a single commercial loan lead.

This is why I have just finished a wonderful new training course for commercial mortgage brokers, SBA lenders, and bank loan officers enitled, Marketing for Commercial Real Estate Loans.  This $199 training course was written in 2012, and it contains all of my latest high-tech techniques for generating commercial loan applications as easily as turning on a spigot.

First of all I will share with you all of the marketing schemes for generating commercial loans that do not work.  Over the past 31 years I wasted over $1 million dollars on marketing schemes that were a complete bust.  I soooo wish I could have taken a course in commercial mortgage marketing instead of wasting that $1 million.  If I had only bought farmland with that $1 million that I had wasted on unsuccessful marketing schemes...

Then I will teach you a number of simple and proven methods for marketing for commercial real estate loans that work as reliably as turning on a water spigot.  This course is written in the form of 52 separate lessons on commercial mortgage marketing.  To see a sample lesson (five slides), please click on the link below:

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Topics: commercial mortgage marketing