Commercial Loans and Fun Blog

Considering Global Income in Commercial Mortgage Finance

Posted by George Blackburne on Wed, Apr 24, 2013

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Most commercial real estate lenders insist that a commercial property's net operating income be at least 125% of the proposed annual loan payment (debt service).  More precisely, traditional commercial lenders often insist on a debt service coverage ratio of at least 1.25.

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Ocassionally the subject property is so desirable that it sells at a ridiculously low cap rate.  A cap rate is the return on your money that you would enjoy if you purchased the property for all cash.

For example, let's suppose you bought an average office building for $1 million, and the office produced an $80,000 per year net operating income.  Eighty thousand dollars (your annual return) divided by $1 million (your investment in the property) equals 0.08.  Mulitplied by 100% give you 8%, which would be the return on your investment ... also known as your cap rate.

Okay, but have you ever priced decent apartment buildings in Chinatown in San Francisco?  So many thrifty Chinese savers would love to own one of these apartment buildings that they bid the sales price up into the stratosphere.  An apartment building generating $80,000 in net operating income in Chinatown might sell for $2,667,000.  Let's compute the cap rate.  Eighty thousand dollars divided by $2.667 million, times 100%, produces a cap rate of just 3%.

Now we are finally getting to the point of today's lesson.  If a traditional commercial lender is going to insist on a debt service coverage ratio of 1.25, this wonderful apartment building in Chinatown might only qualify for a new first mortgage of 46% loan-to-value!  This means the buyer would have to put down 54% of the purchase price.  Who has that kind of money?

If only a lender would be willing to consider income outside of the subject property.  After all, the buyer is a very successful plastic surgeon.  He makes $750,000 per year.  He can easily afford the negative cash flow on a $1.8 million new loan.

When a commercial real estate lender will consider the outside income of the borrower, it is often said that this lender will consider global income.  Here we are proposing that the plastic surgeon put down $867,000 or 32.5% of the purchase price.  At only 67.5% loan-to-value ratio on a very desirable property, the commercial lender is still very well-secured.

So how do you find commercial lenders willing to consider global income?  Certainly hard money lenders - like Blackburne & Sons - will consider global income.

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Small commercial banks located close to the subject property (near Chinatown, in our example) will also often consider global income.

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Topics: global income