Before you begin shopping for a commercial real estate mortgage, you’ll have to address several issues to make sure your business is the right candidate. A trustworthy broker can help you determine if a commercial mortgage is right for you, but here are some of the questions you’ll need
While strong credit and a solid business plan are important to getting a commercial real estate mortgage, the most significant factor the lender looks for is your available cash flow. Lenders look at two key ratios to determine if you can consistently make timely payments – loan to value and debt service coverage.
The loan-to-value ratio (LTV) is the amount you wish to borrow divided by the appraised property value. For example, if you put 25% down and borrow the rest of the purchase price, your LTV is 0.75. The lower the ratio, the better candidate you are for lower interest rates.
Debt service coverage ratio (DSCR) is essentially a “financial cushion” that ensures your property will provide more income than you need to make monthly mortgage payments. Lenders determine your DSCR by dividing your net operating income (NOI) by your monthly interest and mortgage payments. Your DSCR needs to be at least 1.25 or higher to be considered at low risk for a loan.
Typical commercial real estate mortgages start at $400,000 to $500,000 or more. To secure a mortgage of this size, your business will need to make a sizeable down payment. Commercial lenders generally require 20% to 30% down payments. Some lenders might accept 10% down if your other finances look strong, but you’ll pay a higher interest rate in exchange. And unlike residential mortgages, you can’t finance commercial property with “zero money down.”
With a mortgage, cash troubles are especially dangerous because the building itself is the collateral for your loan. If you miss payments, or your DSCR falls below 1.25, the bank can foreclose on the building to recoup their losses. If buying a property means overextending your finances, you may want to continue leasing until your business is in a better cash position.