Commercial vs. Residential Loans

Published January 28, 2012

Commercial loans have historically been made foremost to the property, whereas residential loans are made primarily to the borrower. For a commercial loan, the net operating income of the property is foremost in the commercial lender’s mind, then the condition and location of the property. However, since the recession started, the quality of the borrower is just as important as the merits of the property.

It is evidenced in the appraisals, that these two types of loans are quite different. On a commercial loan, the commercial lender orders an appraisal that has an income approach, a sales comparison approach and sometimes a cost approach. A residential appraisal has the sales-comparison approach and a cost approach. For a commercial mortgage, the income approach is king. This is because the commercial lender is most concerned that the net income of the property will pay the mortgage plus a margin left over for the borrower. A residential lender is mostly concerned with the income of the borrower who will be making the payments.

A commercial lender is also looking primarily at capitalization rates for the market where the property is located and the subject property, as well. Residential properties do not have cap rates. The capitalization rate is derived by dividing the value or sales price of the property by the net operating income.

For example, if a property is being sold for $1,000,000, and the net income of the property is $100,000, the cap rate would be 10%. Or it would be stated that this property is being sold at a 10 cap.

By Terry Painter, President