René Nelson with Pacwest Commercial Real Estate asks the expert Isaac Grant, commercial lending officer with Northwest Community Credit Union, what factors go into analyzing loans and debt coverage ratio for commercial real estate in Eugene.
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René Nelson: Let’s talk about debt coverage ratio and how you analyze a property. I know that’s changing right now in this market and I know that it also changes for different types of assets. Talk to me about debt coverage ratio and what that looks like.
Isaac Grant: Debt coverage ratio is something that your lender is going to talk about a fair amount, and they should be discussing that in the upfront conversations with investors as to how they’re going to measure the property’s net operating income. As you mentioned, it’s different or different property types.
Debt Coverage Ratios for Commercial Real Estate in Eugene
Isaac Grant: Typically, a minimum debt service coverage ratio that a lot of people use in the marketplace will be somewhere around a 1.25. Some will go as low as 1.2. That means for every dollar of debt that you’re taking against the property, we want to see $1.20 or $1.25 of net operating income so that the income produced by the property far outweighs the amount of debt that you’re taking against it.
Rene Nelson: And in relation to that, you obviously want to see some financial statements in relation to the property. Often, we only have the offering memorandum upfront until we have an accepted purchase agreement and we start into the due diligence process, and then we’ll typically get financial statements from either the owner or the property manager. We get the last three years of the owner’s tax returns. So in the initial upfront process, when you’re just doing some quick calculations to tell someone what they qualify for, are you comfortable going off of the operating memorandum that we have to just start that initial conversation?
Isaac Grant: We’ll typically use the information provided on the offering memorandum, but with the understanding that we’re going to need that information backed up with the historical financials. If we’re looking at a proforma and an offering memorandum, we can use those numbers, but with the understanding that the loan amount may be reduced once we’ve actually been able to take a look at the historical information provided to us. We would do that If there’s a major discrepancy between the proforma and the actual in place net operating income that the property’s producing.
How Debt Coverage Ratios Differ Between an Office Building and a Multifamily Property
Rene Nelson: Do you have a different debt coverage ratio for multifamily versus an office building?
Isaac Grant: We do. It’s on a case-by-case basis, but most financial institutions are going to have written within their policy slightly higher debt service coverages for what would be seen as higher risk properties. Properties that are single use or single tenant may have a slighter higher debt service coverage because they offer a higher risk. If a single-use property goes vacant, there’s nothing else to support repayment of that loan from the subject property. In a multifamily situation, if you have a couple of tenants leave on a larger complex, the property’s usually going to be able to absorb that, so it would qualify for a lower debt service coverage.
Rene Nelson: In today’s market and as just a general rule of thumb for multifamily, should most borrowers assume a 30 percent down payment roughly? And I know it depends on cashflow and net operating income, but as a rule of thumb, does about a 30 percent down payment sound right?
Isaac Grant: Historically we’ve seen 25 percent cash down. In the current marketplace you’re going to probably be looking at more like 30 percent cash down, and, in some cases, 35 percent.