Subprime fallout touches commercial real estate

Posted by New Mexico Real Estate

July 25, 2007

The subprime mortgage fallout is affecting all areas of real estate. Even commercial properties are being subjected to tightening underwriting standards. What does this imply? The monthly income generated by a property needs to be bigger than the monthly loan payment, which implies that the property has been priced properly.

The ratio used to measure this is called a debt coverage ratio or DCR. The DCR measures a property’s ability to meet interest payments. The better the net operating income “covers” the loan, the more likely the property can pay its debt. (Net operating income refers to gross rents, less operating expenses such as taxes, insurance, utilities, repairs and maintenance, landscaping, pest control, property management fees and other expenses excluding interest on the loan and depreciation.)

This highlights a problem with current rental property prices: few meet the 10 percent rule. A quick scan of the Las Cruces MLIS, for example, shows

a $200,000 duplex with gross monthly rents of $1,100 or $13,200 per year (6.6 percent)

a $205,000 four-plex with gross monthly rents of $1,280 or $15,630 (7.68 percent)

a $200,000 triplex with gross monthly rents of $1,660 or $19,920 per year (9.96 percent)

Remember these are gross rents, not the rent after monthly expenses such as utilities, maintenance and repairs, property management fees, etc. To determine the actual debt coverage, operating financial statements are needed. But also remember these numbers use the sales price, not the amount that would be financed after a down payment.

By Annette West, Las Cruces Sun-News

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