Direct Capitalization Rate (CAP Rate)

COMMERCIAL LOAN RATIOS

When a commercial loan committee underwrites a potential loan package, their primary criterion includes using three different ratios in evaluating the loan.

Debt Service Coverage Ratio

The Debt Service Coverage (DSCR) Ratio is defined as follows:

DSCR = Net Operating Income (1)
Mortgage Debt Service (2)

For Example:

1.25 DSCR = $62,500 Net Operating Income
$50,000 Debt Service

Other derivatives of the formula are as follows:

Net Operating Income = Overall Capitalization Rate X Value

Overall Capitalization Rate = Net Operating Income
Value

(1). The formula for calculating Net Operating Income is as follows:

Potential gross income (all figures are on an annual basis)

Scheduled rent $xxxx
Other income $xxxx

Total potential gross income $xxxx
Vacancy and collection loss -xxx

Effective gross income $xxxx

Operating expenses

    Fixed                                          $xx
    Variable                                       $xx
    Replacement allowance            $xx

Total operating expenses -$xxxx

NET OPERATING INCOME $XXXX

(2.) Mortgage Debt Service is the annual amount of all periodic payments for interest and retirement of the mortgage loan(s).

Loan-To-Value Ratio

The Loan-To-Value (LTV) Ratio is defined as follows:

LTV = Total loan balances (1st mtg + 2nd mtg)
Fair market value (determined by appraisal)

For Example:

75% LTV = $500,000 (1st mtg) + $250,000 (2nd mtg)
$1,000,000

Debt to Income Ratio

Debt Ratio = Monthly Debt Obligations
Monthly Gross Income

The Debt to Income Ratio compares the amount of bills that the borrower must pay each month to the amount of gross monthly income he earns. It should be added that unlike residential lending, not much emphasis is placed on this ratio in the commercial lending realm. Most of the emphasis will be placed on the income property's ability to "carry" itself by the income it generates.

Need answers on a particular commercial loan you are working on? We encourage you to run your "Commercial Loan Scenario Request" by us and we will respond with our best-case scenario from over 600 Capital Sources. On the rare occasion that we have not been able to place a commercial loan package ourselves, we have always been able to help point the customer to the right source.