Let ’ s try to review and simplify some key valuation terms that lenders may consider before approving or denying a borrower ’ s request :
Loantovalue ( LTV ): The proposed loan amount as a percentage of the estimated property value . Many lenders prefer a loantovalue range between 50 % and 75 % LTV range . For purchase deals , these same lenders prefer that their clients put upwards of 25 % to 50 % of the purchase price as a cash down payment , depending upon the creditworthiness of the borrower and the property type .
Net Operating Income ( NOI ):
The NOI for a commercial property can be summed up as follows : Gross Income Operating Expenses = NOI
The property ’ s operating expenses include insurance , property management , utilities , and other daytoday costs related to maintaining the property . However , the mortgage payments are not included within the NOI calculation .
Cap or Capitalization Rate : It ’ s a mathematical formula used to calculate the real or projected future rate of return on a property based on the net operating income that the property generates . The lower the cap rate , the better the property . Higher cap rates , in turn , are viewed as riskier investments . Cap Rate = NOI / Current Market Value
Property values and cap rates are inverse to one another like a seesaw . Decreasing cap rates as seen with prime downtown properties that are fully occupied leads to increasing property values . Conversely , rising cap rates for older rundown commercial properties usually correspond with falling property values .
Value Estimate : The property ’ s value estimate can be determined by way of the following formula : NOI / Cap Rate .
For example , let ’ s look at two multifamily apartment buildings located in different cities with the exact same NOI but cap rates that are not nearly the same :
Building 1 : $ 160,000 NOI divided by an 8 % cap rate ($ 160,000 / . 08 %) = $ 2,000,000 value .
Building 2 : $ 160,000 NOI divided by a 4.5 % cap rate ($ 160,000 / . 045 %) = $ 3,555,556 value .
Generally , multifamily apartment rates have the lowest cap rates for incomeproducing properties that aren ’ t considered to be residential ( onetofour unit ) properties . According to an analysis for the second quarter of 2022 by Real
Capital Analytics and the NAR , here are their numbers :
Property Type Cap Rate Apartments 4.5 % Industrial 5.7 % Office 6.3 % Retail 6.3 %
DSCR : The easiest way to remember the debt service coverage ratio ( DSCR ) is that it ’ s used to determine whether or not a property has positive ( 1.25x ), neutral or breakeven ( 1.0x ), or negative cash flow ( 0.75x ). The DSCR is the ratio of operating income that ’ s available on a monthly or annual basis to service or cover the monthly mortgage payment ( principal , interest , property taxes , insurance , etc .). As a mathematical formula , the DSCR can be visualized as follows : NOI / Debt Service .
A small retail center that generates $ 10,000 per month in operating income and has a projected $ 8,000 per month in total mortgage payments would be calculated at 1.25x DSCR because the monthly or annual cash flow is 25 % higher than the debt service ($ 10,000 / $ 8,000 = 1.25x ). The net difference between $ 10,000 inflow and $ 8,000 debt service outflow is $ 2,000 . This can also be calculated as $ 2,000 divided by the $ 8,000 in debt service ($ 2,000 / $ 8,000 ), which equals 25 % more net cash flow to arrive at 1.25x DSCR .
45