Commercial real estate loan
A commercial realestate loan is a commercial mortgagetaken out by commercial ventures, by offering a non-residential, commercialproperty as collateral against the loan amount. Normally, commercial real estate loans are termed as nonrecourse, wherein the lender or the creditor can only seize themortgaged property. If the sale proceeds of the property are lesser the totalloan amount, the creditor does not have recourse to claim the balance amount.However, specific agreements are also entered to in several cases, where thedebtor has to pay the balance amount also, if the foreclosure of the mortgagedproperty does not result in the realization of the full debt amount.
Terms of commercial mortgage
The repayment period of a commercial mortgage varies from 5 to 30 years. However, in severalcases, for loans with periods longer than 10 years, the agreement requires theborrower to settle the entire amount at the end of the tenth year, which iscalled balloon payment. Invariably, the borrower would tend to obtain arefinancing of the loan at this juncture, mainly to take advantage of thepossible higher value of the property at that time, and a possible lowerinterest rate prevailing in the market. The interest rates for commercial real estate loans areusually higher than the rates for residential mortgage. Still, the interestrate would be a fixed interest rate over the entire mortgage period, whereasinterest rates for residential mortgages are typically floating rates.
Underwriting commercial real estate loans
While underwriting commercialmortgages, the financial agencies tend to give more importance to thecommercial value of the property than to the commercial standing of theborrower. The commercial mortgageunderwriters typically look for a healthy debt service ratio, in the range of1.2:1 to 1.35:1. Some lenders even look for a ratio of 2:1. Debt service ratiois termed as net cash flow before revenues, less expenditure, excluding themortgage payment, over the mortgage payment. This is in contrast to residentialmortgages, where only the financial repayment capacity of the borrower is takeninto consideration, even if the property is cash flow negative.
/p>Still, most of the commercialmortgage lenders not only look at the commercial value of the property, butalso the location of the property. Even if the property is of very high valueat the moment, the yield from the property could dwindle over years, if thelocation of the property is not ideal. The track record of the borrowers andearnings of the concern over the past several years are also given dueimportance. Market trends and supply-demand positions of the market too aretaken into consideration while deciding on the appropriate terms for commercial real estate loans.In recent times, in the
/p>However, recently both Fanny Mae and Freddie Mac wereriddled with charges of inappropriate accounting practices with the intentionof showing higher earnings and lesser risk. Both the companies conceded thatthere was enough truth in those accusations. They paid substantial penalties tosettle the investigation by the US Securities & Exchange Commission. Anumber of top officials of both the companies were forced to resign. Proposalsfor several regulatory changes that would have better control over theoperations of Fannie Mae and Freddie Mac are being mooted.
Conduit Lending
For the last 10 years, investment banks have taken uponthemselves the servicing the commercial mortgagesas well as the selling of these loans as bonds. These types of loans, called conduit lending, are executed underhighly standardized guidelines. This is in contrast to the earlier processwhere the banks and other financial institutions made the loans and sold themas bonds to investment banks. The investment banks are able to generate morerevenue out of this process by way of selling or trading the bonds. Hence, theinterest rates are more attractive in these loans.
/p>However, there is a risk to this kind of operation. If theinterest rates have risen in the market over a period, the borrower would tendto prepay his loan. This could result in a loss for the stakeholders. On theother hand, the investors of bonds that are commercial mortgage backedsecurities (CMBS) stand to benefit, if the interest rates go down over aperiod. Normally, these commercial mortgage backed securities usually havebuilt-in safety precautions like lockout provisions, prepayment penalties,defeasance, and yield maintenance to protect investors. The structure ofcommercial mortgage backed securities is invariably in multiple tranches. Theyalso tend to have lesser prepayment risks than other mortgage backed securitieslike residential mortgage backed securities. To conclude, the commercialreal estate loans market is at an interesting juncture, with both agencylending and conduit lending fighting for space in the
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