Do Banks Use a Formula When Lending on Commercial Property?

Banks have a variety of ways of analysing a Commercial property; but there are a few guidelines they all tend to use.

For them, the most important number is the property’s Net Operating Income — which is basically rental minus expenses.number crunching

As simple as that may seem, the calculation can vary dramatically from lender to lender.

Calculating the Net Operating Income is fairly straightforward.

Gross Operating Income

You start with take the rental of the property (what you collect from your tenants whether it be office, retail or industrial).

Then, you subtract a vacancy factor (banks use a vacancy factor related to the property type and location) to arrive at your Gross Operating Income.

Less Expenses

Typically, expenses include items such as … rates & taxes, utilities, insurance, repairs & maintenance, property management and so on.

And by subtracting your total expenses from your Gross Operating Income, that leaves you with the Net Operating Income (NOI).

Debt Coverage Ratio

From there, financiers use what is called a called a Debt Coverage Ratio — which can vary depending upon location and risk factors.

The higher the risk, the higher that Ratio.

Think of this as kind of a buffer for the NOI … basically, providing financiers with the comfort that your property will cover their exposure.

And in today’s environment, financiers are extremely cautious in their lending.

In other words, they will be very conservative in assessing the income; and probably use a higher vacancy factor than what the property actually has.

Plus, they will tend to beef up the expenses in arriving at a rather conservative Net Operating Income.

It is this figure that financiers then divide by their Debt Coverage Ratio, to produce a mortgage figure they feel could adequately be secured by the property.

Loan to Value Ratio

Of course, financiers also look very closely to recent comparable sales and and rentals; and will always have the property professionally valued before deciding on a final loan amount.

Nonetheless, financiers will still tend to adopt a Loan to Value Ratio, which can vary based upon the location and risk involved.



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Chris Lang


Chris is a respected Valuer, Real Estate Agent and Auctioneer. Since the mid-1970s, he has been a regular keynote speaker at a wide range of business conferences and seminars around Australia. Many high net-worth clients seek his guidance in acquiring Commercial property. Visit: Commercial Property Made Easy

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