Commercial brokerage underwriting is different from residential, and venturing into either of them is no easy feat. It takes a lot of guts, money, and smarts to be able to pull it off. There are also different factors to consider that you’d have to spend quite some time studying and understanding before you can even say you’re ready. And, if you are planning to secure a loan to finance the commercial or residential property you are interested in, there are several things you need to learn about as well.
Below are just some of the most important aspects about acquiring a real estate loan you have to know about:
What is a Brokerage Company?
First off, you have to understand what a brokerage company is and why there seems always to be one or two involved in real estate dealings. Basically, a brokerage acts like a middle person between sellers and buyers to facilitate a transaction. Their compensation usually comes in the form of fees or commissions upon the successful completion of a deal.
In the real estate industry, cooperation between real estate brokers representing each party involved in a transaction is customary. This collaboration is usually part of making a sale and ends up with both firms dividing the commission.
What is Underwriting?
Now that you have a basic idea of what a brokerage firm is, the next thing you have to know about is underwriting. You’ve probably heard of this term before and wondered why it is always related to insurance or taking out loans. This is mainly because lenders use underwriting to ascertain a potential customer’s creditworthiness.
Aside from looking into the reliability of a person and their application, underwriters also research the risks involved in lending money or insuring a person before doing any business with them. So, essentially, underwriting is the process of checking facts and doing due diligence on the part of the lender or insurer before they assume any risk.
What is Brokerage Underwriting, and How does this Apply in Real Estate?
With both those terms out of the way, we now move on to knowing what brokerage underwriting is about. Originally, brokers or brokerage companies were not involved in underwriting. However, things eventually changed, and now most integrated brokerages have both brokers and underwriters in their employ.
This means that brokerage firms handling real estate, whether commercial or residential, now have their underwriters who establish the number of risks a lender is willing to take. These underwriters are different from those who handle securities and who ascertain the offer price of financial instruments. Real estate underwriters are the ones who look into the borrower and the land or the property.
Borrowers need to have an appraisal done on the property they are interested in. It is the underwriter’s role to ask for this appraisal and to use it to know if the money from the property’s sale is enough to cover the amount borrowed. They also ensure that other factors concerning the property are checked. These include possible dangers to the property like earthquakes, floods, or other natural disasters, making sure there is no other person on the property’s title.
Usually, the property itself serves as the collateral against the amount borrowed for real estate loans. Underwriters mainly use the debt-service coverage ratio (DSCR) to establish a property’s ability to redeem its value. If a property can do this, then the loan is seen as a certain proposition and will have a better chance of being approved.
The Differences Between Commercial and Residential Brokerage Underwriting
If you are debating between investing in commercial and residential real estate, you must already know the differences between the two. As a refresher, residential real estate consists mainly of a property with one to four units, including single-family homes, duplexes, triplexes, and quadplexes. Meanwhile, commercial real estate has five primary types of assets: retail, office, multifamily, hospitality, and industrial. Although they are two sides of the same coin, their main difference lies in the fact that residential real estate is strictly for living purposes. Commercial real estate is where you can have both residential and commercial activities done together.
Now, when it comes to the loan process for commercial properties, you have to expect that the transaction is more complex and usually takes longer than residential properties. This is because residential lenders center on checking out the borrower, while commercial lenders look more into the property itself. Although commercial lenders also qualify borrowers, their underwriters spend more time on determining whether a property can indeed generate revenue or not. This is the main difference between commercial and residential brokerage underwriting.
To understand more of this, here’s a brief look into what’s basically considered when it comes to underwriting commercial and residential real estate loans.
Commercial Brokerage Underwriting
As mentioned above, getting a commercial real estate loan is tough, and the underwriting process is long. Your creditworthiness will be reviewed with care, and they will look into your credit history as a borrower as well as your net operating income, debt service coverage ratio or DSCR, and effective gross income, among others.
Then, there is the loan-to-value ratio or LTV. This is calculated by dividing your loan amount by the value of the property. If you get a low LTV, then your loan will have a better chance of approval. Most commercial mortgage lenders prefer borrowers with an LTV ratio falling between 65 and 85 percent.
Once your LTV has been established, the next step underwriters will conduct a maximum loan analysis. This will determine the full amount you can borrow by going for the least loan amount shown by LTV and DSCR.
Then, there is also the Stress Test, a simulation method that measures how property will fare under different scenarios. This will establish potential returns or vacancy rates and will show a property’s profitability. Only once every conceivable model or plan has been tested, and everything else checked out when you can be declared good for your commercial real estate loan application.
Residential Brokerage Underwriting
Although applying for a residential real estate loan will still require underwriters to look into the vacancy rate, rent growth, cash flow forecast, and potential returns of a property, you can be sure that they will focus more on your credentials borrower. Preparing all needed documentation beforehand and submitting them promptly will help speed up the process. This will usually run for a couple of days to a week, which is definitely shorter than expected if you were requesting a commercial real estate loan.
Residential real estate underwriters will look into your assets and liabilities to verify your income and net worth. They will also review your payment history as a borrower and check your track record in paying different credit sources on time. Your credit score and check credit history will also be considered.
Once everything has been checked out, including your paperwork, you will be qualified as a good risk or not. Qualifying as a good risk means you meet all of your loan’s terms and conditions and can be relied on to pay on time.
As you can see, the main differences between commercial and residential brokerage underwriting lie in the complexity of the process and the length of time needed to complete both. Underwriters will also focus more on the borrower’s qualifications for a residential real estate loan. At the same time, the property’s viability as an investment will be threshed out more for a commercial real estate loan. Understanding this will allow you to choose which of the two you wish to take a risk on, as underwriting is definitely something you cannot evade when you seek funding for your business venture.
For More Information, Contact:
John (Adam) Watson, CEO, CanCap Mortgage Group Inc.
Email: adam@cancap.one Tel: 416-452-5281