Commercial mortgage

A commercial mortgage is a mortgage loan secured by commercial property, such as

an office building, shopping center, industrial warehouse, or apartment complex. The
proceeds from a commercial mortgage are typically used to acquire, refinance, or
redevelop commercial property.
Commercial mortgages are structured to meet the needs of the borrower and the lender.
Key terms include the loan amount (sometimes referred to as "loan proceeds"), interest
rate, term (sometimes referred to as the "maturity"), amortization schedule, and
prepayment flexibility. Commercial mortgages are generally subject to extensive
underwriting and due diligence prior to closing. The lender's underwriting process may
include a financial review of the property and the property owner (or "sponsor"), as well
as commissioning and review of various third-party reports, such as an appraisal.
There were $3.1 trillion of commercial and multifamily mortgages outstanding in the
U.S. as of June 30, 2013. Of these mortgages, approximately 49% were held by banks,
18% were held by asset-backed trusts (issuers of CMBS), 12% were held by
government-sponsored enterprises and Agency and GSE-backed mortgage pools, and
10% were held by life insurance companies.[1]

Terms
Loan amount
The loan amount of a commercial mortgage is generally determined based on loan to
value (LTV) and debt service coverage ratios, more fully discussed below in the section
on underwriting standards.

Loan structure
Commercial mortgages can be structured as first liens or, if a greater loan amount is
desired, the borrower may be able to obtain subordinate financing as well, sometimes
structured as a mezzanine note or as preferred equity, which generally carries a higher
interest rate.

Interest rate
Interest rates for commercial mortgages may be fixed-rate or floating rate. Fixed-rate
mortgages on stabilized commercial real estate are generally priced based on a spread to
swaps, with the swap spread matched to the term of the loan. Market interest rates as
well as underwriting factors greatly affect the interest rate quoted on a particular piece
of commercial real estate. Interest rates for commercial mortgages are usually higher
than those for residential mortgages.

Fees

Many commercial mortgage lenders require an application fee or good-faith deposit,

which is typically used by the lender to cover underwriting expenses such as an
appraisal on the property. Commercial mortgages may also have origination or
underwriting fees (paid at close as a reduction in loan proceeds) and/or exit fees (paid
when the loan is repaid).

Term
The term of a commercial mortgage is generally between five and ten years for
stabilized commercial properties with established cash flows (sometimes called
"permanent loans"), and between one and three years for properties in transition, for
example, newly opened properties or properties undergoing renovation or repositioning
(sometimes called "bridge loans"). Mortgages on multifamily properties that are
provided by a government-sponsored enterprise or government agency may have terms
of thirty years or more. Some commercial mortgages may allow extensions if certain
conditions are met, which may include payment of an extension fee. Some commercial
mortgages have an "anticipated repayment date," which means that if the loan is not
repaid by the anticipated repayment date, the loan is not in default.

Amortization
Commercial mortgages frequently amortize over the term of the loan, meaning the
borrower pays both interest and principal over time, and the loan balance at the end of
the term is less than the original loan amount. However, unlike residential mortgages,
commercial mortgages generally do not fully amortize over the stated term, and
therefore frequently end with a balloon payment of the remaining balance, which is
often repaid by refinancing the property. Some commercial mortgages have an interestonly period at the beginning of the loan term during which time the borrower only pays
interest.

Prepayment
Commercial loans vary in their prepayment terms, that is, whether or not a real estate
investor is allowed to refinance the loan at will. Some portfolio lenders, such as banks
and insurance companies, may allow prepayment flexibility. In contrast, for a borrower
to prepay a conduit loan, the borrower will have to defease the bonds, by buying 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.

Borrower entity
A commercial mortgage is typically taken on by a special purpose entity such as a
corporation or an LLC created specifically to own just the subject property, rather than
by an individual or a larger business. This allows the lender to foreclose on the property
in the event of default even if the borrower has gone into bankruptcy, that is, the entity
is "bankruptcy remote".

Recourse

Commercial mortgages may be recourse or non-recourse. A recourse mortgage is

supplemented by a general obligation of the borrower or a personal guarantee from the
owner(s) of the property, which makes the debt payable in full even if foreclosure on the
property does not satisfy the outstanding balance. A nonrecourse mortgage is secured
only by the commercial property that serves as collateral. In an event of default, the
creditor can foreclose on the property, but has no further claim against the borrower for
any remaining deficiency.
If a sponsor is seeking financing on a portfolio of commercial real estate properties,
rather than a single property, the sponsor may choose to take out a cross-collateralized
loan, in which the all of the properties collateralize the loan.

Reserves
Lenders may require borrowers to establish reserves to fund specific items at closing,
such as anticipated tenant improvement and leasing commission (TI/LC) expense,
needed repair and capital expenditure expense, and interest reserves.

Underwriting
Underwriting metrics
Lenders usually 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 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.
Lenders look at rents per square foot, cost per square foot and replacement cost per
square foot. These metrics vary widely depending on the location and intended use of
the property, but can be useful indications of the financial health of the real estate, as
well as the likelihood of competitive new developments coming online.
Since the financial crisis, lenders have started to focus on a new metric, debt yield, to
complement the debt service coverage ratio. Debt yield is defined as the net operating
income (NOI) of a property divided by the amount of the mortgage.

Underwriting practices
Lenders typically do thorough extreme due diligence on a proposed commercial
mortgage loan prior to funding the loan. Such due diligence often includes a site tour, a
financial review, and due diligence on the property's sponsor and legal borrowing entity.

Many lenders also commission and review third-party reports such as an appraisal,
environmental report, engineering report, and background checks.

Providers of commercial mortgages

Banks
Banks, large and small, are traditional providers of commercial mortgages. According to
the Federal Reserve, banks held $1.5 trillion of commercial mortgages on their books as
of June 30, 2013.[1]

Conduit lenders
Conduit lenders originate commercial mortgages and hold them as investments for a
short period of time before securitizing the loans and selling CMBS secured by the
underlying commercial mortgage loans. Conduit lenders include both banks and nonbank finance companies. Approximately $560 billion of commercial mortgages were
held by issuers of CMBS as of June 30, 2013, according to the Federal Reserve.[1]
Securitization of commercial mortgages in its current form began with the Resolution
Trust Corporation's (or RTC's) commercial securitization program in 1992-1997. The
RTC applied an approach similar to the one it had begun successfully using with
residential mortgages, issuing multiple tranches of securities secured by diversified
pools of commercial mortgage loans.[2] Following the introduction of the securitization
methods by the RTC, private banks began to originate loans specifically for the purpose
of turning them into securities. These loans are typically structured to forbid
prepayment beyond a specified amortization schedule. This makes the resultant
securities more attractive to investors, because they know that the commercial
mortgages will remain outstanding even if interest rates decline.
New CMBS issuance peaked in 2007 at $229 billion. Then, the subprime mortgage
crisis and the resultant global financial crisis caused CMBS prices to fall dramatically,
and new issuances of CMBS securities came to a virtual halt in 2008-2009. The market
has begun to recover, with $12 billion in new issuance in 2010, $37 billion in new
issuance in 2011, and $48 billion in new issuance in 2012.[3]

Government agencies
Government-sponsored enterprises such as Fannie Mae and Freddie Mac, as well as
government corporations such as Ginnie Mae, are active lenders for multifamily
commercial real estate (that is, apartment buildings) in the United States. Approximately
$390 billion of multifamily residential mortgages were held by government-sponsored
enterprises or Agency and GSE-backed mortgage pools as of June 30, 2013,
representing 12% of total commercial mortgages outstanding and 43% of multifamily
commercial mortgages outstanding at that time.[1]

Insurance companies

Insurance companies are active investors in commercial mortgages, and hold

approximately $325 billion of commercial mortgages as of June 30, 2013.[1]

Mortgage brokers
Mortgage brokers do not provide commercial mortgage loans, but are often used to
obtain multiple quotes from different potential lenders and to manage the financing
process.

Correspondent Lenders
Correspondent Lenders do not loan their own money, but provide front end services
such as origination, underwriting, and loan servicing for lenders that utilize these types
of companies. The correspondent often represents lenders in a particular geographic
area.

Other markets
United Kingdom
Commercial mortgage market
Analysis of HM Revenue and Customs data for property transaction completions in the
United Kingdom between 2005 and 2013 shows that, unlike residential lending,
mortgage lending for non-residential property was on the decline prior to the 2008
2009 global recession. Gross commercial and residential lending began picking up at a
similar pace from 2009 onwards, exhibiting 16.2% and 18.2% non-inflation adjusted
growth respectively between 2009 and 2013.[4]
In 2014, commercial lending represented just 5.2% of overall gross mortgage lending
by volume, but 25.3% by value. The average commercial mortgage in this year was
1.46 million, compared to the average residential mortgage of 236,400.[4]
Slotting
Regulations introduced in 2013 by the Financial Services Authority (FSA) required
banks to hold a risk-weighted amount of capital against commercial mortgages
ranging from 50% to 250% of the loan amount in order to limit their exposure to
commercial property assets.[5] Critics predicted that the larger capital requirements for
large banks could adversely affect the availability of commercial credit; however, the
Bank of Englands 2013 Q4 Credit Conditions Survey indicated that commercial credit
availability to the corporate sector had increased throughout the year.[6]
Regulation
As regulated mortgage contracts are defined as relating to properties that will be used
as or in connection with a dwelling by the borrower or a related person, individual
commercial mortgage contracts and the sale thereof are not regulated by the Financial
Conduct Authority (FCA). There is an exception for mixed-use properties where 40% or

more of the property will be used as a dwelling.[7] By March 2016, however, the UK will
be required to have implemented new rules to comply with the pan-European Mortgage
Credit Directive, which does not draw a distinction between commercial and semicommercial properties; it is therefore currently unclear whether all mixed-use properties
will be brought under FCA regulation when the new regulations take effect, irrespective
of the proportion that is used for residential purposes.
Distinction between commercial and buy-to-let lending
In the UK there is a distinction between commercial mortgages, which are for the
purchase of non-residential real estate, and buy-to-let mortgages, which are for the
purchase of residential real estate to let out to paying tenants. Buy-to-let loans may be
offered by both commercial and residential mortgage lenders.
Buy-to-let mortgages share similarities with both commercial and residential mortgages.
Because of high consumer demand and the lower capital offset requirements, mortgage
lenders are able to offer buy-to-let finance at typically lower interest rates than
commercial mortgages. There is also a degree of regulatory crossover between the buyto-let and residential markets, and many buy-to-let lenders employ underwriting checks
similar to those prescribed by the FCA for residential mortgage applications.[8]
Like commercial mortgages, however, buy-to-let mortgages are underwritten according
to debt-service coverage rather than income multiples. High street banks might calculate
DSCR at 160170% for commercial mortgages and 125130% for buy-to-let
mortgages, while a minority of specialist lenders might calculate it at 125130% for
commercial mortgages and 110% for buy-to-let mortgages.