May 24th, 2010 9:30 PM by Chuck Green
I seem to get a high number of phone calls about how much personal income it takes to qualify for a commercial mortgage. The correct answer is; not neccessarily very much. Last year I closed a two unit project on the coast where the upstairs was an apartment, and the downstairs was a restaurant. Both units were leased but the restaurant was new. The restaurant's newness was a major factor in completing this loan, but the client's small income was not. The client had modest personal income from two part time jobs she held; certainly not enough income to qualify just on that basis. As a matter of fact the client suggested she would need stated income. She did not - the income from the two tenants was strong enough to support and debt service the loan. Her income was not a critical factor in getting the loan completed because of the lease income produced by the property. Many clients are not aware that commercial stated income loans are mostly non-existant these days (stated is mostly hard money in this market). Likewise however many clients feel that they need high personal income to qualify for a commercial loan, and while strong earnings are not a bad thing, there are situations where it is not needed.
The key thing to remember in commercial lending is that the loan is made more on the strength of the building, and less on the strength of the borrower. I have one client who is fairly new to the United States who happens to have a great deal of money, but no actual job. She has established residency and established credit. She has enough money to make a commercial purchase, and plans to buy an apartment building. Basically, her down payment will need to be strong enough to make the lender comfortable (perhaps fifty to sixty LTV), and her loan will need to be small enough so that the income produced by the tenants debt services the new loan to the satisfaction of the lender. Essentially, this consumer is converting an asset (her cash) into an income stream collateralized by commercial real estate.
I have another retired client who has some modest social security income whos primary means of income is a medium sized retail center that he owns. His new loan will close in the next week, and our challenge here was demonstrating to the lender that there was sufficient equity in the project to protect the lender. Additionally, we had to demonstrate to the lender that the income produced by the retail center was strong enough to debt service not only the new loan but to also support the client's living expenses, since in this instance the retail center was the primary source of income for the client and his family. There was some question about the viability of some of the client's tenants, but these issues were resolved. It is not unusual in this climate for lenders to require a review of tenant financials, which while highly intrusive is nontheless a fairly common requirement to complete a loan. In the case of this loan, we were able to demonstrate enough support for the loan that we were able to generate some cash out funds which will be used to re-surface the parking lot and make a few other minor repairs on the property.
The interesting thing about commercial lending is that in the opposite situation (to the above) high personal income does not usually trump (or compensate for) a building that performs poorly (weak income flow). The reason for this is that, for commercial properties, income determines property value. Better to have an ugly building that generates cash flow than to have a pretty building that does not.
Another way to look at this is on the basis of cap rate. If you are considering a purchase, and the property shows a cap rate of anything less than 9-10, then the property is overpriced. Often I will see Realtor fliers trying to justify a cap rate of 3-5; the best way to react to this is to walk away quickly. No lender will ever accept or underwrite a property on the basis of a cap rate below eight, unless there are some spectacular compensating factors.
The point is that the property must debt service the loan. I have seen some lenders that allow a "global" cash flow analysis, which is lenderspeak for using the client's personal income to compensate for a property that does not generate the income needed to stand on its own. In a market such as this one, with bargains available, there is no reason to accept any property overpriced and not generating income needed to support a cap rate of 9 - 10.
A smart investor looks at return on investment; and I have never yet seen a building be a good long term investment that did not debt service and cash flow. Don't buy for "equity growth" or appreciation of value - if you are fortunate enough to have that happen then good for you. But stick to the fundamentals with commercial property....and there is really just one key fundamental; income.