Below Average

Defining "Below Average" in Commercial Mortgages

In the context of commercial real estate finance, a "Below Average" mortgage profile refers to a loan application or property that presents a higher-than-normal risk to the lender. This classification typically stems from deficiencies in the borrower's financial standing, the physical condition of the property, or the historical income generated by the asset. Because these loans do not meet the stringent criteria of traditional banks or institutional lenders, they often fall into the category of sub-prime or bridge financing.

A "below average" status does not necessarily mean a loan will be denied, but it significantly impacts the terms, interest rates, and the type of lending institution willing to fund the deal. Lenders view these scenarios as having a higher probability of default, requiring them to offset that risk with more protective loan structures.

Detailed Characteristics of Below Average Mortgages

A commercial mortgage is generally labeled as below average if it exhibits one or more of the following characteristics:

• Low Credit Scores: Borrowers or key principals with credit scores typically below 650-680 are often categorized as below average. This may be due to past bankruptcies, foreclosures, or a history of late payments.
• Weak Debt Service Coverage Ratio (DSCR): The DSCR measures a property’s ability to cover its debt payments. A ratio below 1.20x is often considered below average, as it leaves very little margin for error if expenses rise or occupancy drops.
• High Loan-to-Value (LTV) Ratios: When a borrower requests a loan that represents a high percentage of the property’s value (e.g., above 75% or 80%), it is viewed as a higher risk because the borrower has less "skin in the game."
• Class C or D Properties: The physical asset itself may be below average. This includes older buildings with significant deferred maintenance, functional obsolescence, or locations in declining neighborhoods with high vacancy rates.
• Inconsistent Financial Documentation: Lack of audited financial statements, tax returns showing net losses, or "stated income" scenarios where the property’s cash flow cannot be traditionally verified.

Implications for the Borrower

Securing a commercial mortgage with a below-average profile results in several distinct disadvantages compared to "A-paper" or "Prime" loans:

• Higher Interest Rates: Lenders charge a premium for risk, often resulting in rates 2% to 5% higher than market averages.
• Recourse Requirements: Unlike many high-quality commercial loans which are non-recourse, below-average loans almost always require a personal guarantee from the borrower.
• Shorter Loan Terms: These mortgages are often structured as short-term bridge loans (1 to 3 years) rather than long-term 10-year or 30-year fixed-rate products.
• Stricter Appraisal Scrutiny: Lenders may use "liquidation value" rather than "fair market value" when evaluating the collateral, leading to lower total loan amounts.

Ultimately, a below-average commercial mortgage serves as a temporary financing solution. Borrowers typically use these loans to stabilize a property or improve their credit before refinancing into a more traditional, lower-interest commercial mortgage once the risk profile has improved.