Vacancy/Credit Loss:

A minimum vacancy/credit loss of five percent (5%) will be used on all income, including but not limited to: Rental income, other income and reimbursements. In some cases, lenders will allow income derived from credit tenants to be exempt from a vacancy calculation or calculated at a lesser rate. The actual vacancy calculation will be based on the greater of the market the actual the subject is experiencing, or five percent (5%).

Operating Expenses:

• In general, lenders will look at the greater of what the property is actually expending or what the general rule of thumb in the marketplace would be to operate the subject property.
• Lenders typically use a minimum of five percent for off-site management only in specific circumstances would this be reduced. On-site management (if applicable) is typically reflected by actual value of the subject property and sometimes will be increased to reflect the lender's rule of thumb and/or market.
• The expenses should be broken down (detailed) as much as possible ncluding such items  as administration, supplies, and miscellaneous overhead items.

Underwriting / Non-Operating Expenses:

• Lenders will require either a per square foot expense line item or a percentage of effective gross income as an expense item for reserves for replacement (for apartments, a per-unit figure is used; hotels use a per-room figure, and assisted living uses a per-bed figure). The concept is that this reserve should cover future repairs, replacement of roofs, HVAC, floor coverings, etc. Please note that some lenders, particularly on apartment buildings, require these reserves be placed into an escrow account that is controlled by the lender.
• Most lenders require specific line items for leasing commissions and tenant improvements. These items are based on the calculated rollover risk of the tenants and some factor applied on either a per square foot or percentage basis on selected projects, some lenders require a funded escrow to cover future leasing commissions and tenant improvements.

Debt Service Coverage:

• Debt service coverage becomes an important factor in determining the loan amount. It sometimes supersedes the loan-to-value determination. Typically, the lenders today require a minimum of 1.25 debt service coverage. This means a project can lose up to 25 percent of its income and still be able to make the mortgage payments.
• The debt service coverage varies by the type of property, age/condition of property, loan-to-value, risk of tenant roll-over and other various factors.
• High debt service coverage coupled with a low loan-to-value commands the lowest/best interest rates.

Perspective of the Lender:

The lender underwrites the property as if they were going to own and operate it. Historically, lenders have not been able to manage and operate property as efficiently or as economically as the borrower/owner(s).  Therefore, their point of reference on expenses are always higher than what is either actually being done or what a borrower can actually accomplish.

Impound / Escrow Accounts:

Most lenders today require impound accounts for property tax and insurance. One-twelfth of the total annual property tax and one-twelfth of the total annual hazard insurance is collected each month along with the monthly mortgage payment and held by the lender until such a time that the insurance premium and property tax are due. Rarely does the lender pay interest on these accounts. The purpose of the accounts are to insure that no lapse in insurance occurs or that the property tax goes unpaid because the borrower is "robbing Peter to pay Paul", using the subject property to support an under-performing property.   The insurance escrow may be waived under certain conditions, but the property tax escrow is rarely waived unless paid directly by a credit tenant(s). Some lenders require an impound/escrow account for replacement reserves, and or other items such as tenant improvements for a major tenant vacating.

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Links to:

Mortgage Terms and Definitions
Premilimary Package Requirements