Commercial Notes

Editor’s Note:
“Commercial Notes,” a new monthly column written by David Eaton, president of Manchester-based Eaton Partners Inc., provides answers to reader questions related to commercial real estate financing. Questions can be submitted to him at

Q. I want to refinance my 24-unit multifamily property so I can purchase my siblings’ interest in my family’s summer home. Is there a simple method for me to identify approximately how much money I can borrow?

A. The amount of a commercial loan for an income property is primarily established by analyzing the net income available from the property to support the debt service.

Under the process, gross potential income (GPI) must be established using the rental and other sources of income from the property. Prepare a rent roll by listing each apartment unit and the rent you are receiving or could receive (if currently vacant) on a monthly and annual basis. Add to that amount any other income the building produces from laundry, parking or other sources, and you have identified the GPI.

From the GPI, a vacancy factor must be deducted to arrive at adjusted gross income (AGI). The vacancy factor is usually the larger vacancy percentage experienced by the property over the last 12 months. Most stabilized multifamily properties will be underwritten with a vacancy factor of between 5 and 10 percent.

AGI will be reduced to net operating income (NOI) after the operating expenses of the property are deducted. Last year’s operating expenses are the easiest to use as the base to work from and can be retrieved from your income tax returns or income and expense statements that you or your management company prepare. If you have more current information than last year’s, it should be used. The goal is to present a snapshot of anticipated operating expenses for the upcoming 12 months. Upward adjustments will need to be made to last year’s operating expenses (applying a 3 percent annual increase is usually reasonable). Operating expenses can vary from year to year and usually increase, but in the categories of snow removal and maintenance, for example, it is not uncommon to have annual fluctuations. The lender will apply a management fee as a part of your operating expenses, even if you self-manage the property.

A management fee of 6 to 8 percent is acceptable, unless there is something unusual about the property.

A further deduction for replacement reserves is taken from NOI to arrive at net income. Replacement reserves are earmarked for the capital improvements that must be made to the property over time and are usually estimated to be between $250 and $350 per unit, on an annual basis.

Once net income is established, the mortgage loan amount can be calculated by applying a debt service coverage ratio and a loan constant. The ratio is the percentage of net income that a lender will want over and above the annual debt service. Usually a ratio of 1.2 to 1.3 will be required, meaning a coverage of 20 to 30 percent over the amount available to pay debt service. The loan constant is derived by the interest rate and the amortization period and can fluctuate greatly depending on the loan terms offered by a lender.

The commercial mortgage loan amount also must comply with the loan-to-appraised value ratio that the lender will require. Many factors, including sponsor credit and liquidity, affect the commercial mortgage loan terms that a lender will offer.

David B. Eaton, president of Eaton Partners, Manchester, manages the firm’s Commercial Mortgage Group.

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