This blog continues the definitions of various important real estate terms started in Part 1.  Unless a real estate investor clearly understands all these terms their ability to make good real estate decisions is negatively impacted.

Loan to Value:  Loan to value (typically abbreviated LTV) is perhaps the single most important concept for a commercial real estate borrower to understand.  Commercial real estate lenders use the LTV as the most important criterion in their lending decisions.  The LTV percentage represents the amount of equity in the property and is the measurement of lender’s risk.  To obtain the LTV the lender must come up with what they believe is a realistic property value.  Typically, this involves the Lender retaining a commercial real estate appraiser to value the property under consideration for a loan. Once the lender has a value estimate (or they can also use the purchase price) they divide the loan amount into the property value to obtain the LTV percentage.  For example, if a property is estimated to be worth $10,000,000 and the requested loan is $8,000,000 divide $8,000,000 by $10,000,000 for an LTV of 80%.  Most lenders consider an LTV of 70% or less as a good (i.e. safe) ratio.  An LTV of 80% or less is more market level, while an LTV of 90% or higher is considered very high risk.  Because private capital bridge lenders like Montegra place less emphasis on the borrower’s financial statement or credit score, Montegra will lend up to 65% LTV. Banks or life insurance companies place greater emphasis on the financial statement and/or credit reports so they are willing to lend at a higher LTV.

Debt Service Coverage:  The term debt service coverage (typically abbreviated as DSC) is used by lenders on commercial real estate, along with LTV, to help determine the size of the loan they are willing to make on any given income producing property. DSC simply is the ratio of the amount of income (cash flow) a property generates divided by the amount of the annual mortgage payment.  For example:  if a property produces $800,000 of annual income and has an annual mortgage payment (principal + interest + tax reserve) of $600,000 it has a DSC ratio of 1.3.  Institutional lenders generally require at least a 1.25x DSC to approve loans.  A DSC of less than 1.0x means that the income of a property is not sufficient to cover the annual debt service.  Banks and life companies normally will not make a loan with DSC under 1x.  However private money lenders like Montegra are often willing to fund loans to borrowers that may not yet have a good DSC on the theory that the borrower will increase the DSC ratio after they own the property and take steps to increase its income.  That is why savvy real estate investors frequently turn to private lenders for their purchase money loans knowing that by their good management, they can increase their DSC ratio and then get a lower interest institutional loan.  Unless they are able to buy the property in the first place, they will not have the opportunity to use their management skills to increase the annual income and thereby increase the market value of the property.

For Part III of this Blog, click here.