Commercial Loans and Fun Blog

Commercial Loans and the Operating Expense Ratio

Posted by George Blackburne on Mon, Apr 27, 2020

Loan on apartment buildingIn negotiating an income property loan, the size of loan the borrower can obtain is usually more of a sticking point than the rate or the loan fee.  

Since income property loan sizes are generally limited by the debt service coverage ratio (i.e., cash flow), rather than the loan-to-value ratio, the operating expense figure that the lender uses in his calculations is critical.

 

Earn Up to 12% Interest

 

Alligator attack

 

Free Commercial   Loan Software

 

Suppose a property has the following Pro Forma Operating Statement:

ABC APARTMENTS
1234 MAIN STREET
SAN JOSE, CALIFORNIA

PRO FORMA OPERATING STATEMENT

Income:

Gross Scheduled Rents $100,000
Less 5% Vacancy & Collection Loss 5,000

Effective Gross Income: $ 95,000

Less Operating Expenses:

Real Estate Taxes $12,500
Insurance 2,550
Repairs & Maintenance 5,890
Utilities 7,345
Management 4,865
Fees & Licenses 987
Painting & Decorating 3,986
Reserves for Replacement 1,900

Total Operating Expenses: 40,023

Net Operating Income: $54,977

 

Apply For a Multifamily Loan  Includes Agency Lenders

 

Screen Shot 2020-04-27 at 10.46.42 AM

 

Submit Your Loan to 750 Commercial   Lenders Using C-Loans.com.  It's Free!

 

Then we hereby define the Operating Expense Ratio as follows:

Operating Expense Ratio = Total Operating Expenses divided by
the Effective Gross Income

Using our example above:

Operating Expense Ratio = $40,023 ÷ $95,000 = 42.1%

Appraisers and professional property managers often keep track of the operating expenses of the buildings they appraise or manage, and they publish their results. For example, the National Association of Realtors publishes the results of their surveys annually in several hardbound books including Income and Expenses Analysis-Apartments and Income and Expense Analysis Office Buildings.

 

Nine-Hour Video Training Course  How to Broker Commercial Loans

 

Turtle Help

 

Earn HUGE Loan Servicing Fees  Become a Hard Money Lender

 

Get Both Video Training   Programs For Just $849.

 

Lenders have access to these type of publications, and they therefore are reluctant to accept at face value operating expenses supplied by the borrower when their operating expense ratios are less than those experienced by similar buildings in the area.

While it might be possible to operate an apartment building IN THE SHORT RUN at an operating expense ratio of less than 30 to 45%, in the LONG RUN, the end result will be a seriously deteriorated building.

It might be possible to get a lender to accept an operating expense ratio as low as 28% on a very new building, if it had fewer than 10 or so units, and if it had no pool and very little landscaping, and if you had authentic source documents to back up your claim. But in general, lenders will very seldom accept an operating expense ratio on apartments of less than 30 to 35%, and have been often known to use 40 to 45%.

 

List of Commercial Lenders  2,500 For Just $79.95

 

IMG_0294-2

 

How To Market For Commercial Loans   Video Course 

 

The following are factors that will influence the lender to use a higher operating expense ratio:

  1. Lack of individual metering of utilities
  2. Swimming pool
  3. Elevator
  4. Extensive landscaping
  5. Low income area and/or tenants
  6. Presence of families with children

The larger the project, the larger the required operating ratio.  Large projects usually entail extensive recreational facilities and pools, and they often require full-time on-site management teams.

 

Join C-Loans  As a Lender

 

Blouse knot

 

Money Tight?  200-Page Income Property Underwriting Manual - $199

 

Operating expense ratios are not as useful in evaluating most commercial or industrial properties.  The reason why is because the space can be rented on a triple net basis, a net basis, or a full service basis.

Certain commercial properties, however, have surprisingly predictable operating expense ratios"

  1. Self storage facilities:  25%
  2. Mobile home parks:  25%
  3. Non-flagged hotels and motels:  50%
  4. Flagged hotels:  60%
  5. Residential care homes:  85%  (food, nurses, etc.)

 

Free List of 3,159 Commercial Lenders  Sort By Your Own Criteria

 

IMG-0238

Never knew I had a gas mask fetish, but... wow.  :-)

Huge Referral Fees!  Free Insider's Guide

 

If you are a commercial loan broker, and you are not calling every commercial real estate loan officer, working for a bank or credit union, within 20 miles of your office, you are missing out one of the biggest feasts in commercial real estate finance ("CREF") in forty years.  Please grasp this concept: 

Almost every bank in the country is turning down almost every commercial loan request that it receives.  Helloooo?  What are they doing with these turndowns?  

These bankers would welcome anyone who could help them service their high-net-worth clients, especially since you will be taking the deals to a private money lender, like Blackburne & Sons, as opposed to a competing bank, which might steal their client.

 

Apply For a Commercial Loan to Blackburne & Sons

 

IMG_9674

 

Free Mortgage Broker  Fee Agreement

 

Free $549 Training Course

 

Commercial Mortgage Rates Today:

Here are today's commercial mortgage interest rates on permanent loans from banks, SBA 7a loans, CMBS permanent loans from conduits, and commercial construction loans.

Be sure to bookmark our new Commercial Loan Resource Center, where you will always find the latest interest rates on commercial loans; a portal where you can apply to 750 different commercial lenders in just four minutes; four HUGE databanks of commercial real estate lenders; a Glossary of Commercial Loan Terms, including such advanced terms as defeasance, CTL Financing, this strange new Debt Yield Ratio (which is different from the Debt Service Coverage Ratio), mezzanine loans, preferred equity, and hundreds of other advanced terms; and a wonderful Frequently Asked Questions section, which is designed to train real estate investors and professionals in the advanced subject areas of commercial real estate finance ("CREF").

Did you bookmark it?

 

Today's Commercial Loan Rates  Four Databanks of Commercial Lenders

 

Hedgehog

 

Subscribe To Blog

 

 

Topics: operating expense ratio

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%

 

Free Commercial Loan Placement Kit

 

Commercial Loan Size Calculator

 

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.

 

Free List of 3,159 Commercial Lenders  Sort By Your Own Criteria

 

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.

If you found this training article to be instructive, you might want to subscribe to our blog and enjoy free training in commercial real estate finance.  

 

Subscribe To Blog

 

More commercial real estate loans are ballooning in 2016 than in any year in history.  For well-trained commercial mortgage brokers, it will be like a turkey shoot.

 

Nine-Hour Video Training Course  How to Broker Commercial Loans

 

Got a bankable commercial loan?  Find scores of banks hungry to make commercial loans.  And C-Loans is free to borrowers and commercial mortgage brokers.

 

Submit Your Loan to 750 Commercial   Lenders Using C-Loans.com.  It's Free!

 

Topics: operating expense ratio