COMMERCIAL PROPERTY FINANCING

LEARNING OBJECTIVESDiscuss the most common types of long-term

commercial mortgages and their common provisions.

Discuss financing structures that allow lenders to participate in the property.

Discuss the advantages and disadvantages of financial leverage.

COMMERCIAL PROPERTY FINANCING

LEARNING OBJECTIVESIdentify and explain the items commonly

included in a loan submission package.Identify the elements of the loan application

that lenders focus on in making funding decisions.

Discuss the typical sequence of financing for a new development.

COMMERCIAL MORTGAGE MARKET CHARACTERISTICS

The primary market is dominated by commercial banks and life insurance companies.

In recent years, the size of the CMBSs market has grown dramatically.

Commercial mortgages are typically 5- to 10- years, and often include a ballon payment.

Commercial mortgages are often nonrecourse loans.

COMMON TYPES OF PERMANENT MORTGAGES

Balloon MortgagesCommon Loan Provisions

lock-out, prepayment, and yield maintenance provisions

Floating Rate LoansInstallment Sale Financing

Example Commercial Mortgage Loan Terms

Rates – Fixed 7.25-8.15% Rates – Floating 6.60-7.60% Spreads over Treasuries on

Fixed Rate Loans

125-176 bp Spreads over LIBOR on

Floating Rate Loans

100-200 bp Maximum LTVR 75% Minimum Debt Service

Coverage

1.15-1.20 Loan Term 1-10

PERMANENT MORTGAGES WITH EQUITY PARTICIPATION

Participation Mortgagesincome kickersequity kickerscontingent interest

OTHER EQUITY PARTICIPATION ARRANGEMENTS

Joint VenturesSale-Leasebacks

THE BORROWER’S DECISION MAKING PROCESS

Two basic reasons real estate investors use borrowed funds:to increase the size of their purchase

(affordability), and to magnify their expected rate of return

(leverage).Positive and Negative Leverage

The Effect of Leverage

Increased Financial Risk Increased Variability of Returns.

effect on before- and after-tax cash flows.effect on before- and after-tax equity

reversion.

The Effect of Leverage

Initial LTVR 0% 60% 80% NOI in yr. 1 $1,272,500 $1,272,500 $1,272,500

- Debt Service ---- 683,773 857,038 = BTCF 1,272,500 584,727 415,462 Initial Equity 13,375,000 5,350,000 3,375,000 BTCF/Initial Equity 9.51% 10.93% 12.31% Mean IRR 10.68% 14.58% 17.84%

THE LOAN SUBMISSION PACKAGE

Loan ApplicationProperty Description and Legal AspectsCash Flow EstimatesAppraisal Report and Feasibility Study

LOAN UNDERWRITING

The Property and BorrowerProperty Type, Quality, and LocationTenant Quality and Lease TermsEnvironmental ConcernsBorrower Experience and Resources

The Maximum Loan Amount

The Loan-to-Value Ratio:LTV = Vm / Vo

The Debt Service Coverage Ratio:DCR = NOI / Debt Service

The Break-Even Ratio:BER = (OE + DS) / EGI

ACQUISITION, DEVELOPMENT, & CONSTRUCTION LOANS

Land Purchase and Development FinancingConstruction Financing

take-out commitmentsgap loansopen-ended loansmini-perm. loans