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Some Important Facts About First Position Commercial Mortgage Notes
Generating attractive interest is a challenge in today’s low interest rate environment. The attraction of first position mortgage notes lies in the fact that the investor (the lender) is in first position as the lien holder of the property – therefore the hard asset (real estate) that provides security for their investment.
The 50-year average for homeownership in the United States is about 65%. Most experts believe this number is declining as the trend toward rental communities continues and young consumers face challenges in finding sustainable employment that is directly related to one’s ability (and desire) to own a home. The marketing of traditional residential mortgage financing in today’s marketplace has led to a heightened understanding of how these loans work for consumers. Couple that with the competition in the home financing market and it’s understandable why most adults understand home financing. But what about commercial real estate?
Each and every day consumers leave their homes and visit many commercial properties – for work – for dining – for shopping – for entertainment – but few people understand the difference between the commercial financing market and the residential financing market. The term “commercial loan” is primarily divided into “multi-family properties (5 plus units), office buildings, retail centers, industrial and warehouse space, single-tenant box buildings (such as Lowes and Walmart) and special use properties. Gas stations, Access to a commercial loan is very different from a residential loan, whether used by a school, church, etc.
It is a common procedure for lenders to request 2 years of tax returns, bank statements, pay stubs, credit checks and property appraisals when taking out a residential loan. A loan underwriter’s primary focus is the borrower’s ability (via an income and expense model) to make monthly mortgage payments, including taxes and insurance.
In a business loan the lender first looks at the condition of the property and its ability to service the loan through cash flow from day-to-day operations. The lender will request copies of the current lease (rent roll) and two years of the borrower’s operating history. In addition, they will review recent capital improvements, interior and exterior photos of the property, and lien and title searches. With these documents in hand, the underwriter will create a debt-to-service coverage ratio (DSCR) to determine whether the new loan can meet the demands it will carry. In addition, the lender will look at third party appraisals, looking not only at the property in question, but also at the surrounding area and market trends.
A business borrower must have a strong financial and credit history to qualify for a loan. However, the lender places the greatest weight on the property’s ability to sustain the loan rather than the borrower’s personal circumstances. This is in direct contrast to the underwriting of residential mortgages where the borrower’s personal financial situation is of greater concern than the mortgaged property.
There are six sources of commercial real estate loans – portfolio lenders – government agency lenders – CMBS lenders – insurance companies – SBA loans – private money/hard money lenders.
Portfolio Lenders – This includes most banks, credit unions and corporations that participate in commercial loans and hold them on their books until the maturity date.
Government agency lenders – These are companies authorized to sell commercial loan products that are funded by government agencies such as Freddie Mac and Fannie Mae. These loans are pooled (securitized) and sold to investors.
CMBS lenders – These lenders issue loans called “CMBS loans”. Once sold, the mortgages are transferred to a trust that in turn issues a series of bonds with different terms (length and rate) and payment priorities in case of default.
Insurance companies – Many insurers have looked to the commercial mortgage market to increase income on their holdings. These companies are not subject to the same regulatory lending guidelines as other lenders and therefore have more flexibility to create loan packages outside of traditional lending norms.
SBA loan – Borrowers looking to purchase commercial property for their own use (owner-occupied) have the option of using an SBA-504 loan that can be used for a variety of purchases for their own business, including real estate and equipment.
Private Money/Hard Money Loans – For borrowers who cannot qualify for conventional financing due to credit history or property related challenges – hard money loans can be a viable source of funding for their intended project. These loans have higher interest rates and cost of money than other types of loans. These loans meet a need in the commercial mortgage market – regardless of the high cost of borrowing.
Commercial mortgage loans can be either recourse or non-recourse in their design. In a certain resource loan the borrower(s) are personally liable for the loan if the loan is predicated and the proceeds are not sufficient to repay the loan in full. In a non-recourse loan, the property is collateralized and the borrower is not held personally liable for the mortgage loan. Certain non-recourse loans contain a provision called a “bad-boy clause” as part of the loan documents that states that the borrower is personally liable to the borrower for the mortgage loan in the event of fraud, willful misrepresentation, gross negligence, criminal acts, misappropriation of property proceeds, and loss of insurance. can hold
Understandably, in commercial mortgage negotiations lenders prefer recourse loans where borrowers prefer non-recourse loans. In the process of underwriting, the lender and borrower work to create a loan that meets the needs and goals of both parties, and if a problem arises – the loan is not issued.
The world of commercial mortgages offers investors the ability to participate in a marketplace with attractive yields, principal security through lien positions on real estate assets, and an acceptable term for most (12 months to 5 years). The generation of ongoing monthly interest through holdings such as commercial mortgage notes is attractive to both consumers and institutional investors.
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