No Ratio Loans, When do you need them?
When do you need a No Ratio CRE (all assets) or No Ratio Apartment Loan? The answer is easy- when a property doesn't qualify using traditional methods! Let's explore why a CRE or Apartment property won't qualify.
Traditional CRE Loans During Inflationary Periods
When interest rates rise as we've seen in the last 12 months, the need of having more cash flow- is crucial to make deals work, and therefore interest expense or principal balance reduction on the loan is needed if the DCR doesn't make sense. Capital Infusions maybe needed with loans completed in today's market. The combination of high values, high loan amounts, and higher inflation has pushed rates to an all time 15 year high, the result is less approvals across the board for CRE loans. The issue is that properties need to debt service, and essentially pay for themselves in order to qualify- unless it’s an owner occupied investor transaction. The cash flow isn’t sufficient to qualify for these loans being serviced with a 6%, or 7% rate.
Lender Criteria Box
Every Agency lender has to qualify a CRE or Apartment Loan based on the fact that the property will pay for itself. Agency Lenders (Big Banks) use LTV, NOI, Debt Service Coverage Ratio, and Yield Spread (Lender profit for specific risk) as the most important items to determine loan eligibility- secondary items that Agency lenders look for is cross-collateralization, collateral, equity/down used, business debt, personal credit history, P&L/Balance Sheet Statements, operating history of that asset class, debt repayment across other debt loaned if using relationship to approve the deal, toxicity and environmental damage to the property, zoning/usage, and among other items. It’s simple, if the deal makes money, it makes sense to an Agency lender- Agency lenders typically will use and lend to owner users in specific CRE spaces.
The problem is that not all deals are Agency deals.
We know that In commercial real estate finance, any property financed must pay for itself. But what about the properties that don't qualify? These purchases, cash out loans or refinances need a No Ratio Loan to close the deal.
An investor may need to finance a transaction for "x" number of reasons cash out being one of them- the investor may have 100x the liquidity to buy the property in cash but understands debt and needs the debt and leverage so looks for a loan that's not quite hard money and could finance it until its refinanced, sold or repositioned.
When does the No Ratio Loan Makes Sense?
Each lender is different and each lender criteria loan or "box" changes. When interest rates change, so does the "box". Lender’s don’t want to be left holding the bag and each loan that investors close it’s a liability on their books. The lender’s “criteria box” is truly a moving target- every week that interest rates change, so does the loan criteria. The loans that don't qualify traditionally need an alternative loan that doesn't fit on specific boxes- drum roll and please welcome the No Ratio loan. Not quite hard money but non-qualifying income is needed- best of both worlds. The no ratio loan for an CRE deal may make sense when you can resell the asset once entitled for apartments, so you'll gain 3 times the value- but you need to wait the current tenants out to move out to develop so you buy low- and you sell high later- the problem is you lack all cash or need financing to carry you into the deal. You know the property isn't cash flow but the land is highly valued this maybe a reason why you buy using this loan.
The Problem: High Rates, High Asset Values, and Low Debt Service, Inflation.
Remember, that the problem lies with the low debt service, if the interest rate is too costly- or if the property isn't yielding enough cash flow, and is only at .90x DSCR and the payment is still too high after rate buy downs, but the property has one or two unique features and it has one or two vacancies, or the property is being purchased distressed with major renovation work or a major value add play (rents or appreciation aspect) but once you’re done the property will cash flow 1.50x or 2.25x or 2.50x DSCR after- you need a loan to get you there- the No Ratio Loan will get the job done in the mean time.
Traditional Agency & Cross Collaterization
Sometimes cross-collateralization against 5 or 20 assets with low debt and excellent cash flow isn’t worth the 50% return by itself. The solution is perhaps to finance the transaction by itself- without risking your entire real estate portfolio with your traditional agency based lender. Contact us if you have any questions and or interested in applying for a No Ratio Loan for your next CRE or Apartment Loan Purchase.- we'd like to help.
Written by Carlos Campos, MBA.
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