During my last blog , I spoke about the importance of calculating the net income of an investment property. This post will talk about how the calculation of that net income will greatly affect the amount of mortgage money a bank will advance.
When we view income producing real estate the lender is looking at the borrower’s covenant, but more importantly they are looking at the building as its own business entity.
So they will review the income and expenses provided by the borrower or their agent, and look to see if the numbers are realistic or need adjusting. Usually the areas of most concern are the actual income collected, repairs and maintenance expense and property management.
Here is an example of what a lender will receive from a borrower applying for a mortgage.
| Total Rents: | $200,000.00 |
| Expenses: | |
| Property Taxes | $20000.00 |
| Insurance | $5000.00 |
| Utilities | $15000.00 |
| Rental Items | $2000.00 |
| Repairs and Maintenance | $1000.00 |
| Management | $4000.00 |
| Total Expenses: | $47,000.00 |
| Net Income: | $153,000,00 |
Now the lender will take the numbers provided and will adjust them based on their lending guidelines: The numbers provided below are for demonstration purposes only, and do not reflect any particular lender.
| Potential Rental Income: | $200,000.00 |
| Less: Vacancy 5% & Bad Debts: 2% | $10,000.00 $ 4,000.00 |
| Gross Operating Income: | $186,000.00 |
| Expenses: | |
| Realty Taxes | $20,000.00 |
| Property Insurance | $5,000.00 |
| Utilities | $15,000.00 |
| Rental Items: | $2,000.00 |
| Repairs and Maintenance | $5,580.00 |
| Management 5% | $ 9,300.00 |
| Total Expenses: | $56,880.00 |
| Net Income: | $143,120.00 |
We can see a difference of $9,880.00 net income from what the borrower submitted to what the lender is going to use in their mortgage calculations.
One further step the lender will input into the numbers is what they call a “coverage allowance” , which is a safety net number for the lender. Usually the higher the allowance will mean the project is perceived to be a higher risk, or the lender is more conservative.
Lets assume the coverage allowance is 15%, (with some lender it will be higher), this amount will be deducted from the lenders net income and arrive at a new net income to base their mortgage amount.
Here is the amount of mortgage you will receive.
| Net Income: | $143,120.00 |
| Coverage Allowance 15% | ($21,468.00) |
| Net Income for financing: | $121,652.00 |
| Monthly Income to Cover Debt: | $10,137.66 |
| Assume Interest Rate; | 6% |
| Mortgage Payment Factor (20Year Amort.) | 7.13 |
| Mortgage Amount | $1,421,832.00 |
How does what the lender will advance in mortgage money compare to the purchase price of the property?
If we look at the original net income of $153,000 and a cap. rate of 7.5% , then the purchase price would be $2,040,000.00. If we take the net income provided by the lender then the purchase price with the same cap. rate of 7.5% would be $1,622,027.00.
After determining the amount of mortgage they will advance, the lender will now look at their loan to value lending guidelines and the appraised value of the property to see if they are in line.
If the appraisal value came in at $1,900,000 and the loan to value ratio is a maximum of 65% then they would advance the amount of $1,235,000, which would be a decrease of $186,832.
I have demonstrated the basics of how a commercial mortgage is usually calculated, but also keep in mind that each property, lender and investor are unique.
Your comments and questions are always welcomed.
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