There are numerous terms associated with CRE loans including prepayment, net operating income, cash flow, as well some ratios: loan-to-value and debt-service coverage. All of these terms and ratios are critical to become educated on when trying to either understand commercial real estate loans or seeking approval for a loan.

Prepayment and Penalties

Most commercial real estate loan terms often last between five to 20 years. A lender could offer a five year loan with a 20 year amortization rate. Residential loans commonly have 30 year fixed-rate mortgages. The lengths of both the loan as well as the amortization period affect the rate that a lender offers.  It is important to be careful when paying back commercial real estate loans. Unfortunately, there can be various restrictions and prepayment penalties if you decide to settle your debt prior to your loan’s maturity. There are four main penalties to look out for including prepayment penalty, interest guarantee, lockout, and defeasance which is a substitution for collateral.

Net Operating Income and Cash Flow

Net operating income, NOI, is another term to become aware of when educating yourself on CRE loans, and this is equivalent to all the revenue from a given property less operating expenses. Operating expenses could be insurance, property taxes, repair, or property management fees. NOI excludes capital expenditures, depreciation, and amortization. NOI appears on cash flow statements. Lenders seek out investors who properly manage cash flow and this is why cash flow statements are a vital aspect to the commercial real estate loan approval process.

Important Ratios

The loan-to-value ratio measures the value of a loan against the value of a property. It is found by dividing the loan by either the property’s appraised value or the purchase price, whichever one is less. Favorable financing rates are associates with lower LTV ratios and this means an investor has a greater stake in their property. The debt-service coverage ratio is found by dividing the NOI by the annual debt service. It measures a property’s ability to service its debt. Lenders seek out DSCRs of greater than 1.25. Anything below than one signifies a negative cash flow.

CRE loans have numerous ratios and terms associated with them that are crucial to know when developing an understanding of commercial real estate loans including prepayment, net operating income, cash flow, as well some ratios: loan-to-value and debt-service coverage. When it comes time to approach a lender, having a grasp on these terms and how to calculate these ratios will tremendously improve your chances of getting approved.