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Two of the more common reasons for commercial mortgage decline are property value and or concern over net income. As capital sources continue to tighten commercial underwriting standards, borrowers feel the pinch in lower loan to values and higher debt coverage ratios. Transactions that were tight, but doable 3-6 months ago are, in many cases, simply not fundable today.
Building types and or borrower situations that are considered unusual are having a worse time at it, and are often simply ignored. In fact, it is estimated by our contacts at banks, that as high as 80% to even 90% of all commercial mortgage requests are being declined by traditional banks as of this writing (2/1/08).
Value
First of all, banks tighten the “reigns” by lowering loan to value standards. This reduces their exposure as banks are questioning where exactly values are and are going to be. On a refinance it is was not that difficult to find lenders that would go to 80% loan to value 6 months ago. Now, there are only a few lenders in the nation that continue to offer such high ltv’s and they want to be compensated with high margins and fat prepayment penalties. A good example of this is on flagged hotels. 75% ltv on a cash out refinance were common, assuming of course that the net operating income supported the debt a year ago. Today we struggle to find lenders that will go to 60-65%.
There are different ways to compute value as well. For example many hard money lenders will use a shortened marketing period, like 3-6 months as opposed to the normal 9-12 months period. By doing this it often reduces the appraised value by 20-30% of the properties real worth; because the property is essentially being valued on a liquidation standard.
Income
Another way banks reduce their risk is by increasing Debt Service Coverage Ratio’s. This ratio computes a business’s or income properties ability to meet the potential mortgage payments. A typically ratio is a 1:1.2; meaning that for every $1.20 in net income, the proposed mortgage payment cannot exceed $1 dollar. So the owner will still have $.20 left over after all expenses and the commercial real estate loans have been paid.
Banks that are conservative will raise the DSCR to a 1:1.25 or even a 1:1.35 on properties like hotels, assisted living facilities, etc. Sometimes though a bank will become more conservative with this guild line but do it in a less obvious way. For example, they may raise their underwriting vacancy or management percentages from a 3% to a 5% (or as high as 10%)but still say their minimum is an aggressive 1;1.2 - which is basically misleading.
Another component that is often tweaked is the replacement reserves. On office building it’s normally $.20 per square foot for example. By raising that to $.30 psf it further covers their position and makes the loan that much more difficult to qualify for.
Margin
Another issue which is especially relevant today is the widening of margins by banks. There doing this out of uncertainty of the market/risk and or for increased profit. In many cases we have seen banks doable their margins from a year ago. So if you are currently shopping for a commercial mortgage and are confused by the fed lowering the discount rates and yet the rates your quoted are increasing or remain the same it’s due to the bank increasing their margin/spread.
For example, many commercial mortgages are tied to the 5 year swap, an index you may have not heard of before. As of 1/18/08 this index was at an incredibly low 3.3% vs. 5.5% roughly 18 months ago. So if the lenders margin was 4% your actual rate on your loan would be 4%+ 3.3% or 7.3%. Three month ago it was common to see margins as low as 2% -3%, which would have equated into an effective rate in the 6%’s.
One last thought, if you have recently been declined, it is to your advantage to find out why ,so that you can better prepare yourself and your next lender of the issue. Discuss the issue early on, it may not be a problem with the new source or they may have a different way of dealing with it. Do not try to cover it up. Underwriting will discover it and you will waste your time and money.
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