Information about Commercial Mortgage

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.

Commercial mortgages are typically 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. Less commonly, the mortgage is supplemented by a general obligation of the borrower, 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. 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 5 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 10/30. Since residential mortgages do not require this early prepayment, a 30 year residential mortgage could be referred to as a 30/30.

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 (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:

Year	$ owed to bank	$ Paid per year
0	$15,000,000	$1,320,776
1	$14,863,795	$1,320,776
2	$14,727,186	$1,320,776
3	$14,419,010	$1,320,776
4	$14,419,010	$1,320,776
5	$14,245,484	$1,320,776
6	$14,057,555	$1,320,776
7	$13,854,027	$1,320,776
8	$13,633,608	$1,320,776
9	$13,394,893	$1,320,776
10	$13,136,366	$1,320,776

At the end of the 10 year loan term, the borrower would have to pay the remaining balance (balloon payment) of $13,136,366. Note: If this table were continued, '$ owed to bank' would reach exactly $0 at year 30 since the loan type is 10/30.

Commercial Mortgage : Overview

Common applications of commercial mortgage loans include acquiring land or commercial properties, expanding existing facilities or refinancing existing debt.

Commercial Mortgage: An Overview

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 for over 15 years, and may be much longer than this. The Property itself is 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. Information on Meeting the lenders' criteria Most banks and building societies offer commercial mortgages, but you must satisfy the lenders' criteria. 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 on 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 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. These loans are typically based on 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.

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 . The financial institutions who work to obtain the loans for Freddie Mac or Fannie Mae are then primarily agents, and for this reason this area of lending is known as Agency Lending.

Conduit Mortgages

Beginning in the mid 1990s, conduit loans, or commercial mortgages which are designed to have very standardized guidelines so as to facilitate them being sold off as commercial mortgage backed securities, have become popular. This has been part of a trend in the Investment Banking industry to become more "vertically integrated". That is, instead of helping banks and other lenders to provide fix rate products and replenish funds by selling off loans as bonds, investment banks have taken to making the loans themselves, and then selling the bonds themselves. In fact, many times the Investment Banks make little or no money on the loan itself, and only make money by the selling and trading of bonds. For this reason, these forms of loans are usually at a better interest rate then is possible through other forms of Bank lending.

However, there are downsides to this program. Investors in commercial mortgage backed securities want to ensure that their investment will remain at a fixed rate for a fixed period of time, and will not tolerate prepayments without adding a premium onto the interest rate (unlike bank lenders who will accept pre-payments after a certain amount of time). Therefore, for a borrower to prepay a conduit loan, the borrower will have to buy enough government bonds (treasuries) to provide the investors with the same amount of income as they would have had if the loan was still in place. This is known as a defeasance. When a property defeases, the bond it is in will increase in value since the higher risk real estate collateral is being replaced with lower risk US treasuries.

See also

• Credit (finance)
• Loan
• Mortgage
• Annual percentage rate