What are the main factors impacting and influencing commercial real estate lending?
This is a two-sided coin. On one side you have the factors which commercial mortgage lenders look at when evaluating and underwriting individual investor borrowers and deals. Then you also have the factors which impact lenders internally, and their eagerness and ability to lend.
So, what boxes do you need to check off as an investor seeking loans for commercial real estate investing or as an investor making these loans? What other factors should investors be watching to analyze where the market is heading, and how it will impact commercial mortgage credit?
The 3 Main Factors In Commercial Real Estate Borrowing
Each lender has its preferences and programs. There may be some exceptions. Yet, in general, these are the three most important elements a lender will look at when underwriting a commercial real estate loan.
1. Ability To Repay
One of the primary ways to assess the ability to repay the loan in commercial real estate is the income the property is or can produce. This is usually calculated as the DSCR ratio. Which stands for Debt Service Coverage Ratio. That is how much income can be generated in relation to paying back the debt and covering other operating expenses.
2. Willingness To Repay
In retail mortgage lending for the end, homeowners lenders will typically look at consumer credit reports to check the borrower’s history of paying their bills on time. This demonstrates not only their ability to manage credit and debt, but their eagerness to do so, and on time.
In CRE lending, lenders will often look at the borrower’s track record instead. For example, how many deals they have successfully flipped in the past couple of years.
3. Security If They Don’t Pay
Things happen. So, what security does a lender have if the borrower can’t pay? How do they ensure the security of their capital and returns?
In this space, it is mostly about the collateral. The asset being borrowed against. How easily can it be resold to cover the loan and returns expected? Commercial lenders typically offer lower LTVs to account for this.
Additional Factors In Commercial Real Estate Lending
Here are some of the additional factors which can influence the availability of commercial real estate loans, their terms, rates, and costs.
Liquidity
If lenders can quickly originate and then sell loans into the secondary market to make more loans, then they can be more aggressive in their lending.
Market Direction
Lenders are going to be more bullish or bearish depending on the overall real estate market direction. If asset prices are appreciating rapidly, they can be more aggressive in LTVs, and more lenient in underwriting.
In declining markets, lenders will typically price in higher risk with higher costs and rates. They will be more selective in who they lend to. As well as reducing LTVs to account for any reduction in the asset value.
Loan Performance
If the overall CRE debt market is performing well, then risks seem lower. Less capital needs to be kept in reserves to cover defaults. So, more money can be deployed, on better terms.
If mortgages and other credit are seeing spikes in fraud and defaults, then lenders typically tighten up to protect their positions.
