#2 Property Does Not Cash Flow

Number two on the list is the property does not cash flow

For any investment the buyer / borrower wants to get a good ROI, or Return on his investment. That usually means that the amount of money as a down payment will be returned to a borrower in the form of cash flow from the investment in X period of time. The shorter the period of time the greater the Return on Investment. Well that is exactly what the bank wants as well they want a high percentage of a good Return on Investment – they do not want the property back in foreclosure or default.

How does the lender secure that position? They ask that there is an excessive coverage of cash flow to support the debt service of the project. This is more commonly known as debt service coverage ratio. The difference between what the properties is cash flowing and they require debt service for the loan is known as the coverage factor. Most lenders typically are looking at 1.25% to 1.35% DSCR

What does that mean? Very simply for every dollar of debt service that is required you need 1.25 to 1.35 in cash flow. For example a $500,000 loan at 6.0% amortized over 25 years has an approximate payment of $3,225.00. To meet the loan payment of $3,225.00 a property would have to have total cash flow available for debt service of at least $4,200.00 and that is at 1.25% at 1.35% the amount of cash flow to support the project will need to be over $4,350.00 per month.

If the property after all expenses does not have an additional $1,250.00 approximately the deal will not be considered to cash flow. Many times a borrower is going to do their own due diligence and when they figure out their cash flow the project easily supports the requested debt service coverage ratio, so why would a lender turn down a deal for improper cash flow. There are actually many reasons, but they all boil down to this – the lenders expenses that are deducted from the cash flow are not the same as the borrower had deducted.

This will be a topic of another blog post in the near future after we conclude the Letterman list. Make sure you read our book GET Your Loan Closed for an exhaustive study of the way a lender treats cash flow.