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Debt Service Coverage Underwriting Remains Liberal

realtycapital, 15 July 2006, No comments
Categories: Education, News|Views

 Chicago, Illinois, July, 2006 –  With the exception of the loan-to-value ratio, the debt service coverage ratio (“DSCR”) is the most important loan underwriting parameter for sizing an income-property permanent loan.  DSCR is quite simple to calculate – divide the net operating income by the annual debt service payment.  While the calculation is straightforward, DSCR can be one of the trickiest ratios to understand, particularly in today’s extremely competitive lending environment.

Generally speaking a favorable debt service coverage ratio is 125% of the debt service for conventional loans.  Yet acceptable ranges can vary widely.  Credit-tenant, self-amortizing loans can reach to a low of 100% debt coverage (and be considered safe because of the low risk of tenant payment default), while hospitality properties often require 140% or higher.  What’s more, DSCR may be indicated as extremely favorable (e.g., in excess of 150%), but the underlying cash flow is subject to wild fluctuation (e.g., substantial tenant rollover occurring in the near future, or a poor-credit tenant rent roll).

Currently given the high demand for loans by the real estate capital markets, DSCR requirements are much more liberal.  While a range of 120-125% coverage may be enforced based on pure mathematics, the underlying variables of net operating income and debt service are frequently adjusted.  In particular, loan amortization schedules are increased or even eliminated as shown in the example below.

Assuming a $30-million loan supported by a net operating income of $2.7 million is funded based on a 6% interest rate, the following DSCR are computed: 116% with a 25-year schedule, 125% using 30 years and 150% based on interest-only.  The dramatic difference illustrates that lenders can preserve a 125% DSCR by offering amortization schedules in excess of 30 years.

Nat Zvislo, research director for the Real Estate Capital Institute, says “many more variables impact the validity of debt service coverage, including vacancy, reserves and income forecasts.”  Adding, “Lenders maintain funding discipline by looking at all variables in total.”

The Real Estate Capital Institute is a commercial realty market research organization dedicated to studying debt and equity funding trends – current and historic.  Daily market information is posted for various property types via the Real Estate Capital Scoreboard (www.reci.com).   Hourly realty interest rates and indices are available via the Real Estate Capital Rateline at 7RE-CAPITAL (773-227-4825.)

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Las Vegas, NV - February 6, 2010 - According to industry leaders gathering in Las Vegas this week, debt capital is readily available for 2010.  Optimism is in the air and the mortgage lenders are starting to offer more generous terms and conditions.  In summary, timing is excellent for select borrowers in securing debt based on the following conditions:  (1) Recovering economy, (2) Ample supply of capital and (3) Limited supply of financeable real estate assets.  The following highlights summarize the 2010 state of the realty capital markets including an overall outlook and overall funding program offerings:  Back to Basics:  As lenders workout of their legacy problems, new funding goals surface which are clearly more ambitious than 2009. Still underwriting of actual numbers w/o projections, yet inflation fears exist. Most lenders are Indifferent to spreads, but not competition. Valuing real estate properties in a declining market still a challenge. More allocation of funds available above target amounts if deal flow is of sufficient quality Underwriting Dynamics:  As has been the case last year, high-quality projects in major markets backed by excellent sponsorship and cash flow characteristics are most desired—especially based on low leverage of 65% of value.  Location/Property Types: Major MSAs strongly preferred for optional pricing and leverage.  Otherwise a substantially most costly financing with lower leverage. Preferred property types ranked in order:  (1) Multifamily, (2) Credit-Tenant lease of all property types, (3) Industrial, (4) Retail, (5) Office - however medical office ranks equal to Industrial and (5) Lodging. Pricing (Permanent Fixed-Rate Loan): Agency pricing for apartments starts in the low to mid-5% range for 5 year or greater term. Life company pricing starts mid-5% to 6% for 5 years or more term mostly targeted for commercial property pricing (agencies are more competitively priced) More entrepreneurial funds start at 7% or more targeting secondary markets, smaller fundings, older properties and lodging assets. Add a pricing premium of 25 to 50 basis points for loans below $5 million. Yield differential disappearing - typical ($5 to $50 million) vs. larger loans. Forward funds available up to a year based on 6 o 8 basis points premium per month.  Leverage: Above 65% LTV on a select basis combined with lower spreads. Values based on the lower of: (a) purchase price, (b) appraised value or (c) lender imposed capitalization rate.