In today’s compressed cap-rate environment, we very often hear something along the lines of “why do I have to put so much down?”
I hope this post helps illuminate an often-frustrating aspect of a hot commercial real estate market.
“But, what’s my down-payment?”
As a commercial mortgage banker, one of the most frequently asked questions from borrowers is a seemingly basic one: “How much do I have to put down?” This can actually be a very complicated question to answer as it depends on many factors that include property type, tenant credit quality, lease terms, location and market factors, past performance, future performance, investment attitudes, desired loan structure, etc.
The required down payment is just one of many factors when evaluating a loan offer.
Luckily, there is a short cut to give us an idea of the highest possible LTV if you know some basics about the investment. The attached chart illustrates the relationship of Cap Rate, LTV and DSCR for a given interest rate and amortization. The goal in this case is to find the highest available LTV for a given Cap Rate. Since many lenders use a minimum DSCR guideline, using such a guideline can show you the maximum LTV available for a given investment.
For example, a typical top-market multifamily property will be underwritten to a minimum stabilized DSCR of 1.20x on a 30 year amortization. So, if a multifamily property in Long Beach, California is listed at a 4.75% cap rate, and the interest rate on a given loan is 4.50%, the chart would indicate a maximum LTV of 65%, or a down payment requirement of 35%. If the same scenario is run with a more expensive purchase price of 4.00% cap rate, the maximum LTV is just 55% LTV, with a 10% larger down payment required. On a $10MM purchase, that’s an extra $1MM you’d have to come up with for your down payment on the lower cap-rate deal. If you take a few minutes to review the chart, you’ll notice rather quickly by observing the effect that lower cap rates has on the available loan dollars.
Consider all factors when evaluating a loan.
Also remember that many lenders use additional factors such as an “underwritten vacancy” factor or include additional “underwritten reserves” to reduce the likelihood that their investment goes bad. This can fundamentally alter the underwritten NOI, and therefore the underwritten DSCR. Likewise, DSCR is affected by prevailing interest rates as well, so for all these reasons we recommend you use this tool with caution.
Consult with your mortgage banker.
You can see that although there are some guidelines and some basic math can help steer decision-making, there are a lot of factors to consider when shopping for the right commercial real estate loan. The simple “what’s my down-payment” question may not really be the most important question to be asking or considering for your particular situation. In any case, we’re here to help demystify the process and help ensure the right loan structure for your investment needs.