When seeking financing for a commercial real estate property, borrowers often focus on how much they need, while lenders focus on how much they can lend. Understanding how lenders size a loan is crucial to structuring your deal effectively and avoiding surprises during underwriting.
Lender Priorities in Loan Sizing
Lenders use multiple factors to determine loan amounts, balancing risk and return. The most important considerations include loan-to-value (LTV), debt service coverage ratio (DSCR), and stabilized cash flow. These metrics ensure that the loan is adequately secured and that the borrower has the capacity to repay it.
Loan-to-Value (LTV) – The Maximum Loan Amount
LTV is one of the most straightforward ways a lender sizes a loan. It compares the loan amount to the appraised value or purchase price of the property, whichever is lower. Lenders typically offer 60% to 80% LTV, depending on property type, location, and asset quality. The higher the risk, the lower the LTV.
For example, if a property is valued at $10 million and the lender’s max LTV is 75%, the maximum loan amount would be $7.5 million. If your requested loan amount exceeds this limit, you’ll need to bring more equity to the table.
Debt Service Coverage Ratio (DSCR) – Ensuring Loan Affordability
DSCR measures a property’s ability to generate enough income to cover its debt obligations. It’s calculated as:
DSCR = Net Operating Income (NOI) / Annual Debt Service
Lenders generally require a DSCR of at least 1.20x to 1.50x, depending on the property type. A DSCR below 1.0 means the property isn’t generating enough income to cover debt payments, making financing unlikely.
For instance, if a property generates $500,000 in NOI and the lender requires a 1.25x DSCR, the maximum debt service allowed is $400,000 ($500,000 ÷ 1.25). If the loan’s annual debt payments exceed this threshold, the lender will reduce the loan amount until the DSCR meets their requirement.
Stabilized Cash Flow – Future Viability Matters
For properties in lease-up or undergoing repositioning, lenders consider stabilized NOI—the projected income once the property reaches full occupancy. Bridge lenders may size the loan based on in-place cash flow, while permanent lenders focus on the property’s future ability to meet DSCR requirements.
If a borrower is acquiring a value-add property, a lender may offer an initial loan based on current NOI, with a future loan increase available upon achieving certain financial milestones.
The Lower of the Two – LTV vs. DSCR Constraints
Since lenders prioritize risk management, they typically lend based on the lower amount calculated from LTV and DSCR. Even if a borrower qualifies for a high LTV, the loan size may be reduced if the cash flow isn’t strong enough to support DSCR requirements.
For example, if a lender offers:
- 75% LTV on a $10M property → $7.5M loan
- 1.25x DSCR limiting debt service to $400,000 → $6.8M loan
The final loan amount will be $6.8M, as DSCR is the limiting factor.
Other Considerations That Impact Loan Sizing
Beyond LTV and DSCR, lenders also evaluate:
- Interest rates and amortization: Higher interest rates and shorter loan terms reduce the loan size a borrower can afford.
- Property type and location: Riskier property types (e.g., hospitality, retail) often face stricter underwriting.
- Borrower strength: Creditworthiness, liquidity, and experience influence how much leverage a lender is willing to offer.
How to Structure Your Loan Request Like a Pro
To improve your chances of securing financing, structure your loan request based on lender expectations. Present clear financials, realistic income projections, and a solid business plan. If your property is still stabilizing, consider a bridge loan before moving to permanent financing once cash flow improves.
Sizing a commercial real estate loan like a lender helps borrowers set realistic expectations, avoid financing delays, and maximize their loan proceeds. By focusing on LTV, DSCR, and cash flow, you can approach financing with confidence and secure the best terms for your deal.
Recent Comments