How Commercial Real Estate Loan Underwriting Works

If you’re going through underwriting for the first time, you may not know much about this process or how it works. By understanding how commercial real estate loan underwriting works, you can increase your likelihood of a successful loan approval. Vaster Capital is here to help guide you through every step of the commercial real estate investment process.

What Is Loan Underwriting?

Loan underwriting is the process of determining the risk factors involved in lending money to an individual based on credit history, property value, debt analysis, and income-ratios. The underwriting process is used to either approve or deny a loan application.

Oftentimes, there are specific requirements set by lenders that applicants have to meet in order to qualify. For instance, minimum credit scores, income, or debt to income ratios. Additionally, the underwriting process determines how much someone can borrow based on their cash flow, loan to value ratio, and debt service coverage.

Documents You Need for the Underwriting Process

Gathering and organizing your documentation for the underwriting process may seem like a lot of work. Having a clear list can help ensure that you have everything you need for a successful process. Although lenders may have their own specific requirements in terms of required documentation, here are some of the documents that you will likely need during the underwriting process:

Official income statements like W-2s and 1099s from the past two years
Pay stubs from the last 30 days
Federal tax returns from at least the past two years
Official government identification card and social security number
Recent bank statements and other account statements to show assets
Information related to other long-term debts like auto loans, additional real estate loans, credit cards, student loans, etc.

Steps Within the Commercial Real Estate Loan Underwriting Process

The commercial real estate loan underwriting process is in-depth and intense -- involving eight different steps.

1. Credit Report

The first thing that your lender will check is your credit report. They will generally want to see a FICO credit score above 680 but obviously, the higher the better. In an ideal world, you would have a score above 700. They will scour your credit report looking for late payments, defaults, collections, etc. It may be beneficial for you to request your own copy of your credit report beforehand to make sure that it looks good before you move forward in the process.

2. Debt to Income (DTI) Ratio

Another factor that your lender will consider is your debt to income ratio. Also known as DTI, this is a calculation of all your debts compared to your income. This calculation includes debts like other mortgages, credit card debt, auto loans, student loan debt, and more. Generally speaking, you want your DTI ratio to be as low as possible. Lenders may be willing to accept applicants above 36% but your goal should be to get it below 28%.

3. Net Worth

One factor that is considered during the commercial real estate loan underwriting process that generally isn’t included in the residential real estate loan underwriting process is net worth. Lenders take this into account because income isn’t everything. Instead, some lenders like to focus on your assets and they use your net worth to do this by adding up the value of all your assets before subtracting the value of all your debts.

4. Cash Flow

Cash flow is an extremely important factor in the commercial real estate loan underwriting process. Lenders want to make sure that you’ll have enough cash on a consistent basis to be able to afford your monthly mortgage payments. If there’s no money coming in, odds are that you’ll eventually struggle to pay them back.

5. Net Operating Income (NOI)

One thing that lenders use to help determine your cash flow is your net operating income, or NOI. This formula involves taking the property revenue and subtracting the operating expenses to get an idea of how much revenue a property could generate. You should expect to submit documents like a rent roll or proforma in order to accurately complete this calculation. Generally speaking, you will want to see a positive net operating income that generates revenue rather than losses.

6. Loan to Value Ratio (LTV)

From there, the lender will calculate your loan to value ratio, or LTV. This calculation involves using the actual value of the property rather than the purchase price. In order to determine the actual value, an appraisal will be ordered and conducted by a certified appraiser. Lenders have their own guidelines in terms of the LTVs they will accept during underwriting -- but the lower the ratio the better your odds of approval.

7. Debt Service Coverage (DSCR)

The next step in the process involves calculating your debt service coverage ratio, or DSCR. This calculation is performed to determine if the property will generate enough cash flow to cover the monthly loan payments. It involves the previously calculated NOI and dividing it by the annual debt service, or the total amount of payments due in one year. Most lenders are looking for an NOI that is 1.25 times the annual debt service to provide enough cushion for incidentals.

8. Maximum Loan Analysis

The final step in the underwriting process takes all of the information and calculations made so far to determine the maximum loan amount that the borrower qualifies for. The lender will determine your maximum loan amount by taking the lesser of the two loan amounts calculated by the LTV and the DSCR.

Tips to Get Your Commercial Real Estate Loan Approved Quickly

It can be hard to know what lenders are looking for when they are considering your loan application and conducting the underwriting process. While knowing about the general components can help, there are still things you can do to increase your odds of approval:

State your case: Real estate investors need to make a convincing pitch to lenders about their investing strategy and overall goals for the property. You need to convince them that you are worth investing in -- not just the property. Take the process seriously and show them that you mean business. You can do this through your appearance -- dressing professionally. You can also do this through your actions -- submitting a complete application with more than enough evidence to rule in your favor.
Back up your case: Lenders don’t want to just hear talk -- they want the data and numbers to back it up. For this reason, you should take steps to demonstrate the potential of the property using real numbers and detailing future plans that would impress the lender.

Submit a complete application: Nothing hinders the underwriting process more than an incomplete application with missing documents. Make sure that you give the lender exactly what they ask for and make yourself available to answer any questions that come up during the process. If any of your documents are denied for any reason, be sure to rectify this situation as soon as possible to get the process moving again.
Consider an appraisal: If you want to expedite the application, underwriting, and closing processes, you may want to consider ordering an appraisal ahead of time. Odds are that this will be required at some point in the process anyway, and taking the initiative to do it yourself may impress the lender. If you’re planning on using a lot of your collateral for eligibility purposes, you may also want to consider getting appraisals done on these assets to determine their true value and help improve your case.

How Long Does The Commercial Real Estate Loan Underwriting Process Take?

Underwriters want to be thorough in their research and calculations to provide loans to qualified and trustworthy individuals. As a result, underwriting may take some time. Although the process generally takes about a week, it can be delayed due to issues with documentation -- so make sure that all of your documents are in order far in advance.

Wrap Up on Commercial Real Estate Underwriting

The commercial real estate underwriting process can be nerve-wracking and intimidating. Being approved leads to your dreams coming true whereas being denied leads to your dreams being crushed. While you may not be able to guarantee approval, there are things you can do to make the process easier and increase your likelihood of approval.

At the end of the day, make sure to be responsive and transparent with your lender. Your lender should also extend those courtesies in return. If your current lender doesn’t quite meet these qualifications, you may want to consider using a private commercial lender like Vaster Capital. Vaster Capital is based in South Florida and caters to international investors looking to grow their presence in the United States.

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