Creating attractive interest is a challenge in today’s low interest rate ecosystem. The attractiveness of First Position Mortgage Notes is in the fact that investors (lenders) are held in the first position as a lien holder of the character – so there is a hard asset (real estate) providing the security of their investment.
The 50-year average for homeownership in the United States is about 65%. Most experts see that number reducing as the move to rental communities continue to rise along with the challenges that younger consumers are finding in securing sustainable employment which is directly correlated to one’s ability (and desire) to own a home. The marketing for traditional residential mortgage financing in today’s marketplace has produced a higher understanding of how these loans work for consumers. associate that with the competition in the residential financing market and it is understandable why most adults understand residential financing. But what about Commercial Real Estate?
Each and everyday consumers leave their homes and visit multiple commercial similarities – for work – for dining – for shopping – for entertainment – but few understand that differences in the commercial financing marketplace versus the residential financing marketplace. The term “commercial loans” is mainly segmented into “multi-family similarities (5 plus units), office buildings, retail centers, industrial and warehouse space, single tenant box buildings (such as Lowes and Walmart), and specialty use similarities such as gas stations, schools, churches, etc. in spite of of the use the access to commercial loans is quite different than residential borrowing.
In residential borrowing the normal procedure is for the lender to request 2 years of tax returns, bank statements, pay stubs, credit check, and appraisal of the character. The loan underwriters dominant focus is the borrower’s ability (by an income and expense form) to make the monthly mortgage payments including taxes and insurance.
In a commercial loan the lender will first look at the condition of the character and its ability to service the loan out of the cash flow from its day to day operations. The lender will request copies of current leases (rent roll) and two years of the borrowers operating history. In addition, they will review recent capital improvements, internal and external photos of the character, and lien and title searches. With these documents in hand the underwriter will create a debt-to-service coverage ratio (DSCR) to determine if the character can cover the demands that the new loan will carry with it. In addition, the lender will look at third party appraisals paying attention to not only the character in question but also the surrounding area and the trends in the marketplace.
A commercial borrower needs to have strong financials and credit history to qualify for the loan. However, the lender places the greatest weight on the similarities ability to sustain the loan over that of the borrower’s personal situation. This is in direct comparison to the underwriting of residential mortgages where the borrower’s personal financial situation is of a higher concern than the character that is part of the mortgage.
There are six supplies for commercial real estate borrowing – Portfolio Lenders – Government Agency Lenders – CMBS Lenders – Insurance Companies – SBA Loans – Private Money/Hard Money Lenders.
Portfolio Lenders – these are mostly comprised of edges, credit unions, and corporations that participate in commercial loans and keep up them on their books by the maturity date.
Government Agency Lenders – these are companies that are empowered to sell commercial loan products that are funded by governmental agencies such as Freddie Mac and Fannie Mae. These loans are pooled together (securitized) and sold to investors.
CMBS Lenders – these lenders issue loans called “CMBS Loans”. Once sold the mortgages are transferred to a trust which in turn issues a series of bonds with varying terms (length and rate) and payment priorities in the event of default.
Insurance Companies – many insurance companies have looked to the commercial mortgage marketplace to increase provide on their holdings. These companies are not placed under the same regulatory lending guidelines that other lenders are and consequently have more flexibility to create loan packages outside the traditional lending norms.
SBA Loans – Borrowers that are looking to buy a commercial character for their own use (owner-occupied) have the option of employing a SBA-504 loan which can be used for various types of purchases for one’s own business including real estate and equipment.
Private Money/Hard Money Loans – For those borrowers that cannot qualify for traditional financing due to credit history or challenges with the character in question – hard money loans may be a viable source of funds for their intended project. These loans have higher interest rates and cost of money than other types of loans. in spite of of the higher costs of borrowing – these loans fill a need in the commercial mortgage marketplace.
Commercial Mortgage Loans can be either recourse or non-recourse in their design. In a typical recourse loan the borrower(s) is personally responsible for the loan in the event that the loan is foreclosed and the proceeds are not sufficient to repay the loan balance in complete. In non-recourse loans the character is the collateral and the borrower is not personally held responsible for the mortgage debt. In typical non-recourse loans a provision called “bad-boy clauses” are part of the loan documents which state that in the event of fraud, intentional misrepresentation, gross negligence, criminal acts, misappropriation of character income, and insurance windfalls, the lender can keep up the borrower(s) personally responsible for the debt of the mortgage.
Understandably, in commercial mortgage negotiations the lenders prefer recourse loans where the borrowers would prefer non-recourse loans. In the time of action of underwriting the lender and borrower(s) work to create a loan that meets both parties need and objectives and if an impasse presents itself – the loan is not issued.
The world of commercial mortgages offers investors the ability to participate in a marketplace that can have attractive yields, principal safety by lien locaiongs on real estate assets, and durations (12 months to 5 years) that are permissible to most. The creation of current monthly interest by holdings such as Commercial Mortgage Notes is attractive to both consumers and institutional investors.