Key Commercial Ratios Part II

Before I get to a post on the current secondary market credit crunch and how it is affecting Commercial financing, I thought I would quickly finish what I started yesterday.

Though not nearly as important as the Debt Service Coverage Ratio, Loan to Value ratios do affect the types of programs available to borrowers. Here is a quick summary on commercial Loan to Value ratios.


Loan to Value Ratio

The Loan-To-Value Ratio (LTV) is defined as follows:

Loan-To-Value = Total loan balances
_____________Fair market value

Generally the fair market Value of a property is determined by an appraisal. There is one important exception, however. On a purchase transaction, if the appraisal comes in lower than the purchase price, then the lender will use the LOWER of the purchase price or appraisal.

Commercial Lenders are often asked by real estate agents and buyers to base their loan on the appraised value rather than the pur­chase price. Their claim is that they have negotiated a super deal and that the property is worth much more than what they are paying for it. Perhaps so (but generally untrue), but lenders always base their maximum loan on the lower of purchase price or appraisal.

The lender’s argument (it's their money, so there is really very little argument) is that an appraisal is really no more than an estimate of fair market value, no matter how competent or conscientious the appraiser may be. The only true indicator of value is the marketplace in which a willing buyer and a willing seller, each in full knowledge of the salient facts, and neither under undue pressure, agree upon terms. If the property sells for “X”, then it is probably only worth “X”.

Loan-To-Value Ratios for conforming commercial properties seldom exceed 80-90% because the lender always wants some extra protection against default. There are smaller balance programs which allow for higher LTV's than this, but they are usually based on the strength of the borrower and not the property.

A word of caution about these high LTV programs: their rates are usually 2-5% higher than what a conforming program may be able to offer. This may work in the short run, but for long term investors leveraging a property to this extreme has a devastating affect on cash flow.