A commercial mortgage is a loan made using real estate as collateral to secure repayment.
A commercial mortgage is similar to a residential mortgage, except the collateral is a commercial building or other business real estate, not residential property. In addition, commercial mortgages are typically taken on by businesses instead of individual borrowers. The borrower may be a partnership, incorporated business, or limited company, so assessment of the creditworthiness of the business can be more complicated than is the case with residential mortgages.
Some commercial mortgages are nonrecourse, that is, that in the event of default in repayment, the creditor can only seize the collateral, but has no further claim against the borrower for any remaining deficiency. The general reason for this is twofold: many laws significantly prevent the creditor from going after the borrower for any deficiency, and mortgages structured for sale as bonds give a higher priority to constantly receiving some sort of income and therefore require a clause which allows the lender to take the property immediately, regardless of bankruptcy proceedings that the borrower might be going through.
Frequently, the mortgage is supplemented by a general obligation of the borrower or a personal guarantee from the owner(s), which makes the debt payable in full even if foreclosure on the mortgaged collateral does not satisfy the outstanding balance.
Terms of a commercial mortgage
The majority of Commercial Mortgages in the United States, while requiring the borrower to simply make a monthly payment small enough to pay off the loan over a 20 to 30 year time frame, require a balloon payment (a total payoff) after a lesser time frame. The borrower most likely will attempt at that time to refinance the loan or sell the property. Thus there are two elements generally to the term of a commercial mortgage loan: the length of time allowed until balloon payment (known simply as the term), and the amortization. The length of the loan can vary from a matter of days to 30 years. If a loan had a 30 year amortization schedule, but a 10 year term it would commonly be referred to as a 10 year balloon with a 30 year payment schedule.
As an example, assume a $15,000,000 loan at 8% interest with a 30 year amortization schedule and 10 year term (a 10/30 loan) with monthly payments. The payment amount would be $110,065 per month or $1,320,776 per year if it were on a typical 360 day accrual (in Excel: =PMT(8%/12,30*12,15000000,0)*12 ). The principal balance owed (to the mortgage bank) at the end of each of year would be:
At the end of the 10 year loan term, the borrower would have to pay the remaining balance (balloon payment) of $13,158,706. Note: If this table were continued, '$ owed to bank' would reach exactly $0 at year 30 since the loan type is 10/30.
Applications of commercial mortgage loans
Common applications of commercial mortgage loans include acquiring land or commercial properties, expanding existing facilities or refinancing existing debt. Common commercial properties are zoned for office, retail, & industrial purposes.
Commercial premises are purchased for many reasons. One may require bigger premises to cope with expansion, or you may be buying property, whereby the property is directly linked to a business e.g. a hotel. Commercial Mortgages are usually made with terms less than 10 years, but may be much longer than this. The Property itself is usually at risk if payments are not made on time.
Commercial Mortgages are often used for a variety of purposes::
- To purchase the premises of the business.
- For the extension of existing premises.
- Residential and commercial investment.
- Developing the property in other manners.
Lenders' criteria
Most banks and building societies offer commercial mortgages, but you must satisfy the lenders' criteria for qualification. The primary criterion is the debt service coverage ratio or the ratio of cash available to the required loan payments. Some lenders may accept applications where there is an adverse credit history, but most require a positive personal credit rating and clear evidence that your business is creditworthy. Most will apply a loan-to-value ratio and will expect you to invest a proportion of your own money into the purchase.
The lender's decision will also depend on your current business circumstances - a commercial lender will expect your business to be stable and profitable. They may ask to see your business plan and long-term financial projections, to assure themselves that your business has, and will continue to have, the ability to make repayments on the loan. Some lenders impose restrictions on the uses of commercial premises and certain business concerns may be excluded altogether. The terms of a commercial mortgage will depend largely on the type of business you're running and the type of premises or land you want to buy. This is a complex area and it's essential that you seek specialist advice from your solicitor and probably a chartered surveyor.
Underwriting standards
Commercial Mortgage loans are almost always designed to be underwritten based entirely on the attributes of the property being mortgaged, as opposed to the credit attributes of the borrower. To facilitate this, many times lenders require the property to be owned by a single asset entity such as a corporation or an LLC created specifically to own just the subject property. This allows the lender to foreclose on the property in the event of default even if the borrower went into bankruptcy (the entity is known as "bankruptcy remote"). In a normal residential mortgage, a lender would have a difficult time selling a property if the bankruptcy court case is still pending.
Lenders usually also require a minimum debt service coverage ratio which typically ranges from 1.1 to 1.4; the ratio is net cash flow (the income the property produces) over the debt service (mortgage payment). As an example if the owner of a shopping mall receives $300,000 per month from tenants, pays $50,000 per month in expenses, a lender will typically not give a loan that requires monthly payments above $227,273 (($300,000-$50,000)/1.1)), a 1.1 debt cover.
Lenders also look at Loan to value (LTV). LTV is a mathematical calculation which expresses the amount of a mortgage as a percentage of the total appraised value. For instance, if a borrower wants $6,000,000 to purchase an office worth $10,000,000, the LTV ratio is $6,000,000/$10,000,000 or 60%. Commercial mortgage LTV's are typically between 55% and 70%, unlike residential mortgages which are typically 80% or above.
Interest rates
Interest rates for commercial mortgages are usually higher than those for residential mortgages.
The most common commercial mortgage is a fixed-rate loan, where the interest rate remains constant throughout the term. This must not be confused with the typical residential loan which uses the term to denote a 30 year term mortgage that comes with a rate fixed for 30 years. Most commercial loans have fixed periods between 3 and 10 years. The biggest for this is the source of funds. Many banks borrow their money to lend from the Federal Government with a wholesale cost and repackage the money for retail lending. Since the Fed Rate can change every 3 months or so, banks typically do not want to run the risk of their funds costs exceeding the income derived from interest through a loan made to consumer. These loans are typically based on the yields of treasuries, swaps, corporate bonds, or CMBS rates. Loans can also be variable or capped. These rates are usually based on an index such as LIBOR.
A second commercial mortgage is an additional loan on a commercial property secured behind that of the first lien. The second mortgage is subordinated to the first mortgage and therefore carries a higher interest rate due to the higher risk of not being able to recover all losses should the loan default.
Agency mortgages
In residential lending in the United States, the market evolved from one where banks extended loans to borrowers, to one where banks extended loans but those loans were securitized and sold off as bonds. The government sponsored enterprises Fannie Mae and Freddie Mac were created to assist banks in doing this, by stamping the bonds with a guarantee of timely payment, even if the homeowner was late on their payment.
However if the commercial mortgage market for apartment buildings of 5 or more units, Fannie Mae and Freddie Mac do even more than this. Essentially they lend their own money and then securtize the bonds themselves, leaving banks to handle the servicing (ie. billing etc.) of the loan. They have come to dominate the market for apartment lending (2008-07-01)"Commercial/Multifamily Mortgage Debt Grows in Q3". 2008-07-01 . http://originatortimes.com/content/templates/standard.aspx?articleid=2700&zoneid=4 . Retrieved 2008-07-01 . As of December 17, 2007 GSE's were reported to hold 34% of total debt outstanding for multifamily property. Given the recent liquidity crisis due to the sub prime crash of 2007 & 2008, these numb
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