Commercial realestate Financing terms

Commercial Real Estate Financing Terms

Agency Loan: Commercial real estate fixed-rate first mortgage loans secured by income-producing, stable, multifamily and manufactured housing communities that meet specific underwriting guidelines established by Fannie Mae, Freddie Mac, or HUD.

Amortization:The process of spreading the repayment of a loan or the cost of an asset over time. It involves making monthly equal payments, to gradually reduce the principal amount of the loan or the initial cost of the asset while also paying the interest of the Loan.

Bad Boy Carve-Outs: in commercial real estate are for non-recourse loans these carve-outs safeguard commercial real estate Lenders by holding the borrower accountable if they engage in certain unfavorable behaviors, commonly referred to as "bad boy" acts. These acts may include failing to maintain insurance, pay taxes, and disclose material facts to a lender.

Bridge Debt: A short-term loan used to cover a financial gap or transition period. It's typically taken out by individuals or businesses who need immediate funding to cover expenses while awaiting a more permanent and substantial source of financing.

Capital Stack: The combination and order of financing used to fund the purchase of a commercial real estate or multifamily property. It represents the hierarchy of funds regarding repayment priority in case of liquidation or default. At its simplest, the capital stack includes senior debt and equity. As transactions become more complex, the capital stack becomes more intricate and may involve senior debt, mezzanine debt, equity, preferred equity, and subordinated debt. Each layer carries a different level of risk, with senior debt having the highest priority of repayment and equity carrying the highest level of risk. The specific makeup of the capital stack can vary depending on the investment or project.

Collar: A floating rate that includes both an interest rate cap and a floor. This structure is designed to manage the variability of the loan's interest rate. The interest rate caps and floors come at an additional cost, and allow both the lender and borrower to manage their exposure to interest rate fluctuations in a way that suits their respective preferences and risk tolerances.

Conventional Loan: Loans originated by banks and credit unions and not guaranteed by the federal government. These loans are utilized for multifamily, office, retail, industrial, hospitality, healthcare, mixed-use, and special-purpose buildings.

Construction Financing: Financing utilized to build multifamily, office complexes, shopping malls, and other commercial properties. Typically the loan is 18 to 36 months long, may have additional extensions, and generally is interest only. Construction loans can have floating interest rates, construction with permanent financing together, and may have a fixed interest rate.

Debt Yield: The ratio between a property's net operating income (NOI) and outstanding loan amount. Debt yield helps lenders determine how quickly they can generate sufficient revenue to recover losses if a borrower defaults. It can be used on its own or in conjunction with the debt service coverage ratio to determine the maximum loan to value. A higher debt yield indicates a lower risk for lenders, demonstrating the property's ability to generate sufficient income to cover the loan.

Calculation

Debt Yield = NOI / Loan Amount

Debt Service Coverage Ration (DSCR):

is a financial tool used to assess a borrower's ability to meet the debt obligations of a new loan. It measures the borrower's cash flow available to cover its debt payments, including principal and interest.

Calculation
NOI / Debt Service = DSCR
100000 / 80000 = 1.25
A higher DSCR indicates a greater ability to service debt, reassuring lenders and investors about the borrower's financial stability and repayment capacity.

Alternatively, the term used may be Debt Coverage Ratio (DCR) Or Debt Service Ratio (DSR)

Exit Fee: An unavoidable prepayment penalty owed to a commercial real estate lender upon loan repayment. An exit fee increases lender returns without increasing a borrower's interest rate or asking for additional points, which would decrease the borrower's loan proceeds.

Indicative Rate: Sometimes called a soft quote, is an estimate of the interest rate offered to potential borrowers or investors for financing commercial real estate projects. It is not a final offer but serves as an initial approximation of the interest rate that may be applied to the loan or financing arrangement

Interest Rate Floor: Commonly used by lenders to mitigate the risk of decreasing interest rates, especially when they have floating-rate debt or investments tied to variable interest rates. An interest rate floor can limit a lender's exposure to interest rate fluctuations and ensure a minimum level of interest income.

Interest Rate Ceiling: A limit or maximum cap set on an interest rate. It establishes an upper boundary beyond which the interest rate cannot go, regardless of market conditions or other factors.

Loan Constant: (Mortgage Constant) is a financial metric used to calculate the fixed annual payment required to service a loan, expressed as a percentage of the total loan amount. It considers both the principal and interest payments and remains constant throughout the loan term, providing a valuable tool for comparing and analyzing different loan options. The loan constant helps borrowers and lenders assess a loan's affordability and financial viability and determine its potential cash flow obligations.

Calculation

Debt Yield = NOI / Loan Amount

Loan-to-Cost (LTC):A ratio used in real estate construction financing to represent the portion of the total project cost that is financed by a loan. It is calculated by dividing the loan amount by the total cost of acquiring, developing, and improving a property, usually expressed as a percentage.

Loan Amount / acquiring, developing, and improving a property = LTC

Loan-to-Value (LTV): A ratio of the loan amount to the appraised value or purchase price of an asset, expressed as a percentage. It measures the financial leverage in a transaction and assesses the extent to which a borrower's loan is supported by the underlying asset's value.

Mezzanine Financing: a financing tool used during an equity shortfall . Commercial real estate mezzanine financing sits between equity and senior debt in the capital stack. it may or may not be secured by the commercial property. It is more expensive than traditional debt but less expensive than equity. Mezzanine loans are subordinate to senior debt but receive priority over common equity.

Prepayment Penalty: A fee applied when paying off a commercial real estate loan early. There are three standard types of commercial real estate and Multifamily prepayment penalties a borrower's loan may be subject to include:

Step down - In the case of a step-down prepayment penalty, that gradually steps down over time. The fee is calculated using a percentage of the currant loan balance. For example, if there is a five-year loan with five years remaining, the initial fee might be 4%. With four years left, the penalty decreases to 3%, and by the third year, it further reduces to 2%. Finally, in the last year, there is no fee.

Yield Maintenance -is a prepayment penalty calculated based on the present value of the remaining loan payments. Its purpose is to guarantee that the lender obtains the exact yield (interest) as if the borrower had fulfilled all the scheduled payments until the loan reaches its maturity date.

Defeasance -a process by which the borrower substitutes the collateral for the loan with other investments, typically U.S. Treasury securities, which generate sufficient cash flow to cover the remaining loan payments. This complex process requires a specialist to help determine the amount and can help with the process. Defeasing a loan can be costly.

Subordinated Debt: A type of debt ranked below senior debt in the capital structure. This type of debt has a lower priority of repayment and comes with a higher risk level. To compensate Debt providers for this increased risk, subordinated debt holders are offered higher interest rates.

Most Common Types of Commercial Real Estate

Office buildings: These are typically multi-story buildings used for conducting business, such as professional services, corporate offices, and government agencies.

Retail spaces: This category includes shopping centers, malls, standalone stores, and other commercial spaces used for retail sales.

Industrial spaces: These are properties used for manufacturing, storage, distribution, and other industrial purposes, including warehouses and manufacturing facilities.

Multifamily properties: These include apartment buildings, townhouses, and other properties that are used for residential purposes and have multiple units.

Hospitality properties: These include hotels, motels, resorts, and other properties used for short-term lodging.

Healthcare properties include medical offices, hospitals, and other properties used for healthcare services.

Mixed-use properties: These are properties that combine two or more different uses, such as a building with retail space on the ground floor and residential units on the upper floors.

Special-purpose properties: This include properties such as movie theaters, sports arenas, and other properties designed for specific use.