Financing Guidelines for Commercial Properties

Although there are similarities between residential and commercial mortgage, there are specific guidelines and rules that apply for financing commercial properties, which comprise structures such as office buildings, apartment complexes, healthcare facilities and retail outlets. Commercial financing typically involves a lot more paperwork.

While an individual borrower’s credit rating is the primary qualifying factor for residential home financing, commercial mortgages are in most cases underwritten based entirely on the attributes of the property being mortgaged. Since commercial mortgages are typically assumed by businesses instead of individual borrowers, lenders not only require the business to be stable and creditworthy, but they also require the individuals that own the business to have positive personal credit ratings.

Besides checking credit ratings, underwriters also look at the location of the business being purchases, past income generated, as well as projected income. The commercial mortgage terms also depend on the type of business the borrower is involved in and the type of premises or facility that the borrower wants to purchase. The first step in underwriting a commercial property is to calculate the property’s cash flow, which is commonly referred to as net operating income, or NOI.

Debt coverage ratio or DCR, which is defined as the monthly debt compared to the net monthly income of the investment property in question is one of the key components in the loan evaluation process. Lenders typically seek a minimum debt service coverage ratio which ranges from 1.1 to 1.4, which is a net cash flow ratio of the income the property produces and the debt service or mortgage payment. Lenders also consider Loan to Value or LTV. LTV is the amount of a mortgage as a percentage of the total appraised value. Commercial mortgage LTVs are usually between 55% and 70%, unlike residential mortgages which are typically 80%.

The most common commercial mortgage is a fixed-rate loan, where the interest rate remains constant throughout the term. In residential mortgages, the word “term” indicates the time period of the loan during which the interest rate is fixed, as in a 15-year or 30-year term. On the other hand, most commercial loans require a total payoff, known as a balloon payment, after a certain time frame. The length of time allowed between the amortization and the balloon payment is known as the term. For example, if a loan had a 30-year amortization schedule, with a 10-year term, it would be referred to as a 10-year balloon with a 30-year payment schedule.

Unlike residential mortgages, commercial financing often includes a prepayment penalty. This is done because lenders make their money on the interest that is paid throughout the life of the loan and prepayment can cut short their profits. However, in today’s competitive commercial loan market, borrowers can negotiate for the elimination of the prepayment clause.

Commercial Real Estate Market Stabilizing?

For the past several years, commercial real estate had been billed as the next big train wreck. Recently however, many investors have been shouting all aboard! Let’s see why.

The U.S. commercial real estate market ended on a high note in 2010, following blockbuster transactions in December. The sales figure for 2009 was $54.6 billion. In 2010, it increased to $115 billion, a mammoth 109% increase. Over $21 billion worth of transactions took place in December, which was the highest sum for a single month’s trading since the end of 2007. The fourth quarter sales of about $46 billion was comparable to the quarterly sales volume of 2004, which was considered a healthy recovery year.

Almost everyone in this industry was caught off guard by the sudden increase in transaction activity in 2010. Most of this recovery is centered on core assets in primary markets.  Analysts expect to see an increase in activity in secondary markets in 2011.

The apartment market seems to have made a clear shift to recovery mode since the beginning of 2010. The apartment vacancy rate was 7.1% in the third quarter of 2010, down from 8% at its peak in the fourth quarter of 2009. Other areas of the commercial property segments have also shown slight improvements. The national office space vacancy rate was 17.8% at the end of 2010, down by 10 basis points from the 17.9% peak it reached in the second quarter of that year. Commercial property investors are encouraged by the overall trend, and they anticipate a recovery in the leasing markets as well.

No one can guarantee that the commercial real estate recovery train won’t jump the track. There are many hills and valleys it must negotiate such as the rising number of shaky mortgages, weak household balance sheets, slow employment recovery, the recent back-up in bond yields, lack of corporate pricing power and poor fiscal outlooks at all levels of government.

Despite these hurdles and headwinds, some industry experts predict commercial sales to surpass $200 billion in 2011. There are plenty of factors to support such claims including the anticipated higher sales volume in the secondary markets, and an abundance of investor types – foreign investors, corporations, REITs, pension funds and private investors, who have all been waiting for the right time…and 2011 may just be their opportune time period.

Coming Soon

In the near future this blog will be full of information on Real Estate in Central Florida.  Information will be both for buyers and sellers. 

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Foreign Investors Rank U.S. No. 1 Commercial Market

The U.S. commercial real estate market is ranked the No. 1 choice for investment this year and viewed as the best opportunity for price appreciation, according to a survey of foreign investors by the Association of Foreign Investors in Real Estate (AFIRE).

More than 60% of respondents indicated that the U.S. offers the best potential for capital appreciation. This number is a dramatic reversal from 2006 when it reached a lowest level of 23%. The next-ranked country, China, was 54 percentage points behind the U.S.

“As the fear of a double-dip recession has faded, investors are becoming more enthusiastic about the prospects for the U.S. economy and are taking aim at real estate investment opportunities in the U.S.,” said James Fetgatter, AFIRE chief executive.

The survey respondents represent more than US$627 billion in real estate globally, including US$265 billion in the United States, and 72% of them say they plan to invest more capital in the U.S. in 2011 than they did in 2010.

Most Popular Cities

Properties in stronger markets are attracting investor interest, while smaller properties in slower markets continue to display signs of distress. According to the AFIRE survey, investors overwhelmingly chose New York and Washington, D.C. as the two top global cities for their real estate investment dollars.

“Except for multi-family housing, [investors] are not scattering their interest throughout the U.S., but rather narrowly targeting it to New York City and Washington, D.C., to an even greater extent than before,” Fetgatter said.

For the full AFIRE survey report, visit http://www.afire.org/.