DCR for a Rental

An issue I have been hearing different things about is how much weight a lender puts on a rental property’s DCR vs the buyer’s DCR? I know every institution has different requirements but do you guys know of any standard they look for or is there a certain type of property that is easier for a bank to write a mortgage for?

Thanks. Found my next apartment property, but I am close to my income vs debt limit.

If you are getting a residential mortgage loan, the lender will look at your creditwothiness and your ability to pay the loan. Most of the time, the lender does not even consider the income the property COULD produce because the lender wants to know that you can still pay the mortgage if you have no cash flow. In this case, the lender is looking at your debt to income ratio (DTI) to determine if you will still be able to pay the mortgage. If your DTI is above 40, chances are you won’t get the loan.

If you are getting a commercial mortgage to finance your purchase, then the lender wants to see that the property will cash flow AND that the cash flow is sufficient to support the debt service. The ratio that the commercial lender looks at is the DCR (sometimes called DSCR). If the DCR is below 1.2 (1.3 for more conservative lenders), chances are you won’t get the loan.

Yes it is commercial. My scores are in the mid 700’s and the property is a 10-plex with GOI about $48k. What should I expect the bank to want to see?

You need to look at your NOI, not your GOI.

The lender will probably underwrite their own expenses, which is different for every part of the world.

1.2DSCR is good if good areas, 1.3 for less then average

My original question, is there any standard the bank looks for or is there a certain type of property that is easier for a bank to write a mortgage for? I am almost at my debt limit and I am finding so many great deals out there on apartment buildings that I want to take advantage of.

If the property you want to purchase is income producing property, the lender will want to know if the property will cash flow and if that cash flow is high enough to support the debt service. That is pretty standard for all commercial lenders.

Your debt to income ratio is probably irrelevant for a commercial lender.

Some commercial lenders don’t care about your DTI they are mostly interested if the property can not only cash flow now but cash flow later.

Which is why you need to do a lot of due diligence and check the market area to see how strong it is. What the job growth rate is,how strong other commercial properties are,etc.

You need a solid business plan along with a good marketing report and a good cash flow analysis. If you have these chances are you’ll get the loan.

I already own a property in the city. This one cashflows well, 100% occupied, well kept, great price. What do I need to do or get, so the bank will give me a mortgage based on the property and not my income/debt? My credit scores are in the mid 700’s but my DTI is at the limit the bank allows.

In all cases of property loans the ratio of property value and the income from that property is measured. Apart from this, debtor’s paying capability is also judged whether property is commercial or residential.

Just to clarify what shubh said. The lender will look at the appraised value of the property to determine the maximum loan that may be possible. If the lender will only lend up to 80% of the property value, then the maximum loan available for a $250K property is $200K. This is true for both residential mortgage loans and for commercial loans. The residential mortgage lender will now look at your debt to income ratio (DTI) to see if you personally have the income to support the mortgage payment (this is assuming your credit score is high enough for the lender to even process your loan application).

The commercial lender won’t bother with your DTI, but will look at the net operating income the property will generate and calculate the debt coverage ratio to see if the NOI is at least 120% of the debt service. If not, then the maximum loan amount will be reduced to meet the minimum DCR. So, in this example, if the loan rate is 6% on a 20 year amortization and if the property generates an NOI of $18000, then the debt service can be no higher than $15000 per year. The maximum loan the commercial lender will give on this property for these loan terms is about $174500. If the lender requires a 1.3 DCR, then the maximum loan in this example will be $161000.

So you can do as many Commercial deals as you want without your DTI being a problem?

What is a good source for commercial loans? Are the low minimums usually higher than residential loans?

Do you need to be buying in a corporation name or have a corporation to use a commercial loan?

A good source for commercial loans is the bank you’re already at. They have money to lend to local investors, yet the DSCR requirement will likely be a minimum of 1.25. Now, this is calculated with a vacancy factor that is usually AT LEAST 8.33%.

And, they will assign a maintenance factor that is an industry standard that they feel comfortable with, for the age and condition of the property. It would not surprise me that it would be at least 8%.

To that, you’ll likely need to include a charge for professional management, even if you tell them, “I’m going to manage it myself”. To that they’ll say, “that’s great, but what if you get hit by a bus? We’d better put a realistic number in there so we can hire a property manager”. In our area, that’s at least 7% but they will likely want to use 10%. They’re bankers, remember.

So for costs off your performa income you have 8.33% for vacancy, then let’s say 8.67% for maintenance, and 10% for property mgmt. That leaves us with 73% of GOI to pay the bills – property taxes being the largest of those.

In our area, property taxes avg about 20-23% of GOI. So, thinking like a banker, I’m going to take off 23% and now we’re down to 50% of gross. From that, take off any utilities you pay, occupancy permits, licenses, and fees. So, maybe you’re at 47% for an annual NOI. That number, divided by 1.25 would be your the maximum annual P&I for the year. Divide by 12. Then use a maximum term of 25 years, at whatever interest rate they’ll allow, and you’ll be able to compute the maximum loan amount.

In today’s market, I’m going to say that will likely be in the range of 65-75%, unless you make some really great income and a long history with them.

Now, if you can get the seller to carry back some of the principal, at a LOWER rate than the bank, that will sweaten the deal.

As for whether you need to buy in the name of a business, are you running a business, or is this a hobby?

In today’s market, I doubt the commercial lender will give an inexperienced investor a loan with a 25 year amortization. Best do your cash flow analysis on the assumption that your commercial loan financing will be on a 15 year amortization with a five year balloon. If the property is a larger multiplex (five units or more), a 5% vacancy factor is usually acceptable, otherwise for smaller properties assume 10% vacancy.

My scores are in the mid 700’s and the property is a 10-plex with GOI about $48k. What should I expect the bank to want to see?