Financing Commercial Real Estate Purchases – Two Important Ratios

This is the next in a series of posts directed to non-institutional buyers of commercial real estate. By “non-institutional” I mean individuals, families, partnerships, limited liability companies and corporations that own or are seeking to buy small to medium-sized commercial real property.

Buyers of commercial real property fall into two broad categories: users or investors. A “user” buyer intends to use the commercial property purchased to conduct its business. This could be office, retail, or warehouse/industrial in nature. “Investor” buyers purchase the commercial property purely for the rental income the property will generate and for the appreciation on resale thus providing a return on the investor’s investment in the property.

Whether an investor or user loan, commercial real estate lenders are “cash flow” lenders. The value of the real estate is a secondary source of repayment—foreclosure is a last resort. On an investor loan, cash flow from the operation of the asset (net income above expenses) is the key factor in the lender’s evaluation of risk. This is usually expressed as a ratio known as “debt service coverage”. Typically, lenders will want to see a minimum debt service coverage ratio of 1.2 to 1.4 to provide sufficient confidence to make the loan.

Although there is no income on a user loan, a similar analysis of income v. expenses on the part of the borrower will be made. Personal financial statements, personal and business tax returns, and business income and balance sheets will provide the lender the information it needs to make this evaluation.

Loan to value is another important ratio in the decision to lend or not to lend. Loan to value is a simple ratio or percentage expressed by the amount of the loan divided by the value (appraised value) of the property. Note it is the appraised value, not the sales price. This percentage is not dissimilar to residential loan to value analysis. However, in the residential world, loan to value can be as high as 97-100% under government programs provided by FHA and the VA. Not so for a commercial real estate loan. Lenders typically will look for a loan to value of 65-75%. Borrowers with good credit and/or substantial balance sheets will do better, but as a general rule, the lender will be looking for a greater down payment than in the residential arena. One exception is the SBA 504 loan program that can provide up to 90% financing provided the purchaser will use at least 51% of the property for its own business.

In poor economic conditions, banks are less willing to provide pure investor real estate loans resulting in lower loan to value ratios. Banks are a little more flexible on user loans as the owner is directly involved with the asset on a day to day basis.

The commercial real estate purchaser should be prepared to address these issues with the lender when loan application is made.

Rick Lane is a top realtor with Weichert Realtors in the Washington, DC Metropolitan market. He has 20 years’ experience in real estate brokerage and real estate law and construction. He is a winner of a Weichert National Sales Award (top 5% nationwide). He is a former partner in the law firm of Thompson and Waldron and a former Vice President with the Trammell Crow Company in Washington, DC. Rick is a graduate of the University of Virginia and William and Mary Law School. He may be reached at:

Richard F. Lane, Esquire
Weichert RealtorsCommercial
Elkins Lane Realty Advisors
121 N. Pitt Street, First Floor
Alexandria, VA 22314
Direct: 703.888.5106
Cell: 703.626.6691
Office: 703.549.8700
Email: [email protected]
www.elkins-lane.com






This is the next in a series of posts directed to non-institutional buyers of commercial real estate. By “non-institutional” I mean individuals, families, partnerships, limited liability companies and corporations that own or are seeking to buy small to medium-sized commercial real property.