How Lenders Size a Commercial Mortgage: DSCR, LTV and Debt Yield

A residential mortgage is sized mostly on your personal income. A commercial mortgage is sized on the property. Lenders run several tests on the building's income and value, and the loan you get is the lowest result. Understanding these tests before you make an offer helps you know how much equity you will really need.

Start with net operating income

Every test starts from net operating income (NOI): the property's rental income, less vacancy, less operating expenses such as property and school taxes, insurance, utilities paid by the owner, maintenance, management and reserves. Debt payments are not included.

Lenders will usually recalculate your NOI rather than accept the seller's figures. They apply their own vacancy allowance, add a management fee even if you self-manage, and include a reserve for replacements. Expect the lender's NOI to be lower than the listing's.

Test 1: the debt service coverage ratio (DSCR)

DSCR measures how comfortably the income covers the mortgage payments:

DSCR = NOI ÷ annual principal and interest payments

A DSCR of 1.20 means the property earns 20% more than it needs to pay its mortgage. Conventional lenders commonly look for 1.20 to 1.30 or more, depending on the asset and the borrower. CMHC-insured multi-residential loans can go lower: MLI Select uses a 1.10 minimum for standard rental.

To size the loan, the lender works backwards: divide NOI by the required DSCR to get the maximum annual payment, then find the loan that payment supports at the qualifying rate and amortization.

Test 2: loan-to-value (LTV)

LTV compares the loan to the appraised value, or the purchase price if lower. Conventional commercial loans in Canada typically top out around 65% to 75% LTV. CMHC-insured loans can reach 85%, and up to 95% under MLI Select.

Test 3: debt yield

Some lenders, especially for larger or non-residential deals, also check debt yield: NOI divided by the loan amount. It shows the lender's return on its money if it had to take the property back, regardless of interest rate or amortization. It is a quick way for a lender to check that a long amortization isn't hiding a thin margin.

A worked example

Take a Quebec rental building with an NOI of $250,000 and an appraised value of $4,000,000. Assume, for illustration only, a 5.00% qualifying rate (compounded semi-annually, as is standard in Canada) and a 30-year amortization.

• DSCR test at 1.20: maximum annual payment is $250,000 ÷ 1.20 = $208,333. At 5.00% over 30 years, that supports a loan of about $3,250,000.

• LTV test at 75%: 75% × $4,000,000 = $3,000,000.

• Result: the lender offers the lower amount, $3,000,000. The debt yield on that loan is $250,000 ÷ $3,000,000 = 8.3%.

In this example, value is the constraint, not income. If the same building qualified for CMHC insurance, the higher LTV limit could lift the loan, and the income test would become the one to watch. Now flip it: in a high-rate environment the DSCR test often binds first, which is why buyers are sometimes surprised to be offered less than the LTV they expected.

How to improve your loan amount

• Document income properly. Signed leases and a clean, current rent roll support the NOI lenders will accept.

• Show real expenses. Clear operating statements avoid a lender adding generous assumptions on top.

• Compare programs. Insured, conventional and private lenders size loans differently. The same building can support very different amounts.

• Mind the amortization. A longer amortization lowers the annual payment and raises the DSCR-based loan.

WeFinanceU is an AMF-registered commercial mortgage brokerage in Montréal, focused on financing of $1,000,000 and more. We size your deal the way lenders will, before you commit, and match it to suitable lenders from our network of over 20 lenders. Send us your property details.