Commercial/Apartment underwriting terms and sample loan amount analysis used by the industry.
Gross Potential Income (GPI)
Gross income for units applies to apartment units, which can be in operation. Borrower (sponsor) may choose not to rent a unit but you would include this as a unit, which can be rented. Later you may expense it out as an expense line item (managers unit, model, storage, etc.)
Commercial property income is derived from rental income, percentage income from sales, Common Area Maintenance (CAM), real estate tax and insurance reimbursements. Expenses include normal operating expenses, reserves for replacements, Tenant Improvements (TI) and Leasing Commissions (LC).
Gross Potential Income (GPI) from other sources
This income can include: Laundry, parking spaces (if normal for market, storage spaces (if normal for market). All income should be supported by the fact that other complexes in the area use this income and that the income will continue into the future.
Income not normally included are Security Deposits, interest earned, refund of tax monies, etc. If this income is used, you will need to ensure that it will continue into the future, the appraiser and Lender supports the decision to use this income.
Vacancy and collection loss
Vacancy rate is a stabilized rate, which is used for the subject property. It does not represent a moment in time. Normal rates are a minimum of 5% although it could be actually is lower. The appraiser will help set the stage for this one. Also, look at previous operating history. If the project did not operating well during the previous 12 months and the appraiser and underwriter used a lower rate, you would need support data which would be used to justify the lower amount.
Collection loss represents an amount due to bad debts or losses attributed to slow pay. Normal is .5-2%. If this amount is high, look for justification or reasons to allow such a high rate.
Rent Concessions-A discount given to induce a tenant to rent. Typically given for 6 month and 1 year tenants. Normal is ½ rent for one month or 1 month for year. You need to determine the rent turnover per year for the subject property. Then apply the appropriate concession and subtract from income stream.
Effective Gross Income (EGI)
Vacancy/collection and rent concessions minus Gross Potential Income equals Effective Gross Income
Expenses
Fixed expenses are expenses, which are not affected by the vacancy, etc. Taxes, licenses, insurance are normal
Variable expenses are expenses include management, utilities, and maintenance/repairs, administrative, pool, landscaping. Normally, only those expense occurring on a monthly or semi-annual basis.
Capital improvements-Major one time expense (plumbing, electric)-Reserves-Major carpeting, appliances, roofing, exterior painting, fencing, driveway
Net Operating Income (NOI)
The balance remaining after all above income and expenses are applied.
Income and expense analysis is designed to stabilize an income stream for a complex into the future. Reality indicates that most income is high until major improvements have occurred. Then the income drops. Over time, the NOI we calculate will represent the subject over time as well.
Appraisal Terms
Gross Income Multiplier (GIM)
Gross Rent Multiplier (GRM) is the same. Sales price or estimate of value divided by GIM or GRM-$435,000 divided $100,000=4.35. The Income X GRM now will now present an estimate of value. Very quick to determine but may distort the true operating effectiveness of the property. True operating expenses, tenant turnover, bad debt, etc. are not known at this time and may distort property value.
Effective Gross Income Multiplier (EGIM)
Similar as above GIM, but it takes into consideration Vacancy/collection loss and subtracts it from Gross Income. $435,000 divided by $93,500=4.65 X EGI generates a value.
Capitalization Rate (CAP) or Overall Rate (OAR)
They are used interchangeable, but they are somewhat different. The normal use is CAP and this is found in the appraisal. This is a ratio of NOI to the value of the project. Or $43,500/$435,000 sales price or 10% CAP. The CAP rate weeds out many of the variables, as possible to provide the cleanest numbers available to determine value. The only problem is that the data from the comparable sales could be incorrect and the final estimate may be distorted. Therefore, the more comparables the better.
From Income flow Value is determined by various methods
GRI/GRM, GIM, NOI, and price per unit, price per square foot, price per room. Each is used to provide the best estimate the value of the complex (the Cost Approach to value is not given much consideration as most projects are older and there is not reasonable method to determine depreciation, etc.) View all indicators to establish consistency with the appraisers value estimate.
Debt Service Coverage Ratio (DSCR or DSR)
Technical term for “fudge factor”. In underwriting a loan Lenders determine the NOI or cash flow before debt or loan. Due to uncertainties in the market or other factors, Lenders will not use all of a borrowers NOI or cash flow. A “Break Even” position is all of your cash goes toward your new loan. Lenders will withhold a percent or an amount out of cash flow to offset “conditions in the market”. E.G. –A 1.25:1 DSCR means that the Lender will take 25% of your NOI off the top as a “fudge factor” to ensure there is adequate cash to pay all debt during most up and down markets.
Terms used by Lenders
30/360 VS Actual/360
The APR is different due to use of calendar days. 30/360 APR of 6.9% would be 7.1% for actual/360. Wall Street and Conduits are moving to actual/360. Market pays more for this over standard 30/360.
Loan Lock Out
Loan may not be prepaid during a specified period. Retains yield to investor during first 3-7 years of loan term. No prepayment of any kind is allowed, partial included.
Yield Maintenance VS Defeasance
As with Yield Maintenance, Defeasance releases the Borrower/Sponsor’s property from the security. However, unlike Yield Maintenance, Defeasance maintains expected cash flow to the investor in securities originally backed by the Sponsor’s loan. Specifically, when the real property securing a loan is released from the lien, the Lender receives as substitute collateral a security interest in a collection of U.S. Treasuries, or other securities issued by a federal instrumentality supervised or controlled by the Federal government as collateral for the Note. The securities cash flow must at least match the loan’s remaining P & I payments. Typically, loans with Defeasance will provide a greater yield to the investor that is also reflects a lower margin to the Borrower/Sponsor.
Compared to a Yield Maintenance loan, Defeasance is slightly more expensive if Treasury rates at the time of prepayment are below the interest rate on the loan. This is mainly due to having to buy Treasury strips at lower rates along the Treasury curve with Defeasance rather than calculating Yield Maintenance off the remaining term Treasury.
Defeasance does provide the Borrower/Sponsor with the potential to defease the loan at a discount to the current principal balance if Treasury rates have risen above the interest rate on the loan. Under Yield Maintenance the Borrower/Sponsor does not receive any benefit from the higher Treasury rates.