Posted by ray@lcorn on February 25, 2007 at 20:29:22:
Tom,
Lenders typically leave valuation to professional appraisers. They may do a back-of-the-napkin valuation using prevalent cap rates in the market for discussion purposes only, but I usually do that for them in my loan proposal.
(I never leave the math to the lender… I’ve found I’m much better off handing them a complete picture to start the conversation. That way the deal is priced based on my assumptions rather than theirs.)
The lender’s focus will be on the debt service coverage ratio (DSCR). That’s the amount of income available for debt service (DS), expressed as a ratio.
Example for a deal with NOI of $100,000, cost of $1,250,000, and proposed debt of $937,500, 25 year am @ 7.5%.
NOI = $100,000
DS = $83,136
DSCR = 100,000 / 83,136 = 1.2
That means there is $1.20 of income for every $1 in debt service. You’ll find that most like to see a DSCR of 1.25 unless there are long term leases in place. Be aware that they will not take your NOI number as given. They will adjust it downward to reflect management fees, and any other expense increases (e.g. utility prices), or any interruptions in income (e.g. vacancy, lease expirations, tenant upfit expense, etc.) they think might be likely.
In fact the appraised value will often not be known until very late in the underwriting process. That’s because the lender won’t order it unless they are already pretty sure they will make the loan.
ray