Appraised value / cap rates of properties and bank loan terms
Banks lend based on appraised value and property cap rates. Higher the cap rates, higher the returns and generally higher the risk.

So, then how do banks take this higher risk into account? What LTV / DSCR target should you be targeting for a different Commercial properties?
[{"id": "gexqvtx", "text": "We look at ltv based on different cap rate scenarios over multiple years.  We look at quality of tenants and length of leases, that's hard to quantify in just a cap rate, but no matter what someone is buying a property for, we are going to look at what our loan to value would be at a 8/9/10% cap rate.  Hope that helps.", "replies": [{"id": "gexqzva", "text": "Thanks. Are you a lender / work for a bank? What would say is a good LTV vs bad?", "replies": [], "depth": 2}], "depth": 1}, {"id": "gexr2vj", "text": "I am a lender, ideally for us, we are at 80% or less based on 10% cap rate.", "replies": [{"id": "gey0h95", "text": "If you have any 10caps PLEASE message me ; )", "replies": [], "depth": 2}], "depth": 1}, {"id": "gexwxg4", "text": "I think your first comment is generally correct. When referring to cap rates, however, note that you have the cap rate of the actual acquisition and the cap rate that the appraiser uses that is a function on market/industry standards. The actual cap rate could be high (off market, good deal) and the industry standard for the type of deal could be low.\n\nIn terms of you question, there are a ton of factors that go into this. Simply speaking, the higher risk (which you are equating to high cap rate - again, not always the case), the lower the LTV and the higher the DSCR target. All this is relative so would depend on your specific deal (ie an McDs 10 year NNN lease is \"riskier\" than an McDs 20 year NNN lease, but the McDs 10 year NNN lease is way less riskier (depending on other factors, eg basis) than say a 3 year NNN lease to your local bakery).", "replies": [{"id": "gexzpu1", "text": "That's a good point. We have our own model that calculates cap rates based macroeconomic factors like 10Yr Treasury, interest rates, tenant credit, location, property condition etc. So, it's a function of market conditions. \n\n&amp;#x200B;\n\nSounds like general rule of thumb, assuming, \n\n1) high cap rates = high return / risk -&gt; LOW LTV and HIGH DSCR Target.\n\n2) Low cap rates = low return / risk -&gt; HIGH LTV and LOW DSCR Target.", "replies": [], "depth": 2}], "depth": 1}, {"id": "gey1i8z", "text": "Downturns increase cap rates and decrease debt market liquidity.  Both of these make refinancing tougher. Refinancing is often the primary repayment source for loans with a bullet due at maturity. As a lender, I prefer to size based on debt coverage ratio/minimum debt yield because it indicates cash flow, which can support repayment even during down markets. Yes, downturns negatively affect cash flow, but it lags the expansion of cap rates and contraction of available capital. I can restructure a loan with cash flow better than a loan with value. \n\nWhich would you rather have a bullet coming due on? \n\n1. An apartment with rents down 5% but enough cash flow to support ongoing interest and principal with an extension to the maturity. \n\n2. A piece of land where even though values have contracted, you\u2019re still at 70% appraised LTV. \n\nIt should be no surprise, but it\u2019s a lot tougher for a regulated bank to restructure scenario 2 without having to consider it a Troubled Debt Restructure and increase their reserves for the loan. \n\nFor reference, I am placing a medical office loan where one lender is sizing with an 11% minimum debt yield on in place cash flow. They got to 11% based on a 4.5% floor rate, 20 year hypothetical amortization, and a minimum 1.45 DSCR. This seems conservative but lenders are more conservative during pandemic with office and retail. Many lenders still size by  apartments using 1.20x DSCR, the actual rate, and a 30 year amo. \n\nLTV doesn\u2019t usually constrain loans in low cap rate markets. That said apartments see max LTV of 70-80%, whereas commercial is generally tops out around 60-70%.", "replies": [{"id": "geybs42", "text": "Increase cap rates due to downturns and low debt market liquidity indicates the high risk of forbearance or default. However, increase cap rates also mean greater NOI, isn't it? That's not the case during the downturn. \n\nHow should we interpret cap rates then? Are they pricing in the risk factor vs high NOI / returns on the property?\n\nMakes sense re: Using DCR for lending as it indicates cash flow vs low LTV. I imagine some combination of both of those metrics is optimal.", "replies": [{"id": "gez3w2q", "text": "Cash flow isn't moving because of the cap rate. Values are moving because of the cap rate. The cap rate moves based on investor appetite and competing asset classes.\n\nSo in the 2008 downturn, we saw decreased liquidity in capital markets and panic. All of these things decrease the appetite for commercial real estate. This change in risk perception immediately put upward pressure on cap rates. A property that had no change in income would still be worth less.\n\nNOI would change over the medium term as tenants default, skip renewing and vacate, or whatever. The cap rate has no direct effect on NOI.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "geyyz8u", "text": "Lender here. I\u2019m more focused on Debt Yield than cap rates or DSCR. DY ignores the effect of low rates or cap rate compression that can get you in trouble when only looking at LTV or DSCR. No single metric is perfect, but comparing DY across mortgage investment opportunities helps me screen quickly. I look at 500 requests a year and close about 10, so a lot of quick triage needed.", "replies": [{"id": "gezm5a6", "text": "Banker here. What this guy said", "replies": [], "depth": 2}], "depth": 1}, {"id": "geziyie", "text": "Banks lend on the lesser loan amount predicted by a maximum LTV and minimum DSCR. \n\nLet\u2019s say a property appraises based on a super low cap rate (NOI/value). That\u2019s where DSCR factors in and makes the cap rate irrelevant (NOI/debt payments). \n\nBanks take market risk into account by lending based on that risk. Certain property types considered riskier have more conservative loan terms (lower LTV, higher DSCR). \n\nLoan terms vary from bank to bank, and even from borrower to borrower, based on a variety of circumstances that vary in importance at each bank.", "replies": [], "depth": 1}, {"id": "gf85mii", "text": "For CRE as well as C&amp;I, we use a model that takes into consideration several factors to determine the riskiness of the proposed credit facility. Then after we get that probability of default, we use our internal pricing spreadsheet to come up with the Return on Equity. If the ROE is too low then something has to give either higher pricing or lower risk. Otherwise, the lender has to convince the top lending EVP in the bank to grant an exception. And convincing is not easy because the lending EVP answers to the President regarding profitability.\n\n\n/source : I work for a Commercial Bank in a Credit capacity.", "replies": [], "depth": 1}]