Money set aside, or an expense assumed by the lender, for periodic replacement of capital items such as roofs, heating and cooling systems and parking lots.
The OCC handbook defines replacement reserves as a reserve for the periodic replacement of capital items such as heating, ventilation, air conditioning, roof and parking lots. A lender may or may not require the reserve to be funded with cash. Either way, the handbook says, reserves for replacement should be deducted from income in determining net operating income.
That last point surprises many owners. Your own statement may show no reserve line, because you pay for a roof when the roof fails. The lender’s version of your income will include one anyway, which lowers net operating income and with it the loan the property supports. A reserve of $15,000 a year is $15,000 less income available for debt service.
How the amount is set depends on the property. The handbook says reserves for multifamily are underwritten per unit per year and vary with age and condition, and reserves for office, retail and industrial are set per square foot. Some lenders collect the reserve monthly with the loan payment and release it as work is done. Ask early whether the reserve will be funded or only assumed, and at what figure.
How it shows up in the data here
Not in the data. No filing on this site shows a property's reserves or expenses. Call reports give each bank's loan balances by category only. To see the effect of a reserve on coverage, enter it as an expense in the DSCR calculator. For lenders by property type, see multifamily lenders.
Go further
- DSCR calculator: Coverage with reserves counted as an expense.
- Multifamily lenders: Lenders with multifamily loans on the public record.
- DSCR calculator: Cash flow over debt service. Type the cash flow and the loan terms, see the ratio and the cushion before it falls to 1.00x.
- Maximum loan calculator: The loan each test allows: DSCR, LTV and debt yield side by side, and which one binds.
- How bankers evaluate a commercial loan deal: A credit officer asks one question five ways: how will this loan be repaid, and what happens if it is not? Knowing the five tests lets you size a request before you send it.
- Multifamily loan checklist for 5+ unit properties: A larger apartment loan can go to five kinds of lender. They want much the same package. They differ on recourse, term, prepayment, speed and what they ask of the sponsor.
Related terms
- Net operating income (NOI): A property's annual income minus its operating expenses, before loan payments, income taxes and depreciation. It is the top number in DSCR and debt yield.
- Effective gross income (EGI): The income a property is expected to produce after subtracting an allowance for vacancy and for rent that will not be collected.
- T-12 (trailing 12 months): A property's income and expense statement for the most recent twelve months, usually shown month by month.
- Debt service coverage ratio (DSCR): Net operating income, or business cash flow, divided by the loan payments due in a year. It shows how many dollars come in for each dollar of debt service.
- Pro forma: A projection of a property's or project's future income, expenses and cash flow, built on stated assumptions and not on past results.
Sources
Plain definitions for orientation, not legal, tax or credit advice. A lender's own policy decides what it will do.