Some Important Facts About First-Position Commercial Mortgage Notes

Creating attractive interest is a challenge in today’s low interest rate environment. The appeal of first-position mortgage notes lies in the fact that investors (lenders) remain in the first position as holders of property liens, so there is a hard asset (real estate) that provides the security of your investment.

The 50-year median for homeownership in the United States is about 65%. Most experts see the number shrinking as the shift to rental communities continues to increase along with the challenges younger consumers encounter in securing sustainable employment that is directly related to ability (and desire). of owning a home. The commercialization of traditional residential mortgage financing in today’s market has created a greater understanding of how these loans work for consumers. Combine that with the competition in the residential financing market and it’s understandable why most adults understand residential financing. But what about commercial real estate?

Each and every consumer leaves their homes and visits multiple commercial properties – to work – to dine – to shop – to entertain – but few understand the differences in the commercial financing market versus the residential financing market. The term “business loans” is primarily segmented into “multi-family properties (5+ units), office buildings, shopping centers, industrial and warehouse space, single-tenant box buildings (such as Lowes and Walmart), and single-use properties. specialized such as gas stations, schools, churches, etc. Regardless of the use, the access to commercial loans is quite different from the residential loan.

In residential loans, the normal procedure is for the lender to request 2 years of tax returns, bank statements, pay stubs, credit checks, and property appraisals. The primary focus of loan underwriters is the borrower’s ability (through an income and expense model) to make monthly mortgage payments, including taxes and insurance.

In a business loan, the lender will first look at the condition of the property and its ability to repay the loan with cash flow from its day-to-day operations. The lender will request copies of the current leases (rental list) and two years of the borrower’s operating history. In addition, they will review recent capital improvements, internal and external photos of the property, and link and title searches. With these documents in hand, the insurer will create a Debt Service Coverage Ratio (DSCR) to determine if the property can meet the demands that the new loan will bring. Additionally, the lender will observe third party appraisals paying attention not only to the property in question, but also to the surrounding area and trends in the market.

A business borrower must have a solid credit and financial history to qualify for the loan. However, the lender places greater importance on the property’s ability to sustain the loan than on the personal situation of the borrower. This is directly compared to underwriting residential mortgages where the borrower’s personal financial situation is more of a concern than the property that is part of the mortgage.

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 – These are mainly made up of banks, credit unions and corporations that participate in commercial loans and keep them on their books until the maturity date.

Government agency lenders – these are companies that are authorized to sell commercial loan products 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, which in turn issues a series of bonds with different terms (duration and type) and payment priorities in the event of default.

Insurance companies – Many insurance companies have turned to the commercial mortgage market to increase the return on their holdings. These companies are not subject to the same loan regulatory guidelines as other lenders and therefore have more flexibility to create loan packages outside of conventional loan standards.

SBA loans – 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 various types of purchases for their own business, including real estate and equipment.

Private money / hard money loans – For those borrowers who cannot qualify for traditional financing due to their credit history or problems with the property in question, hard money loans can be a viable source of funds for their planned project. These loans have higher interest rates and money costs than other types of loans. Regardless of the higher loan costs, these loans fill a need in the commercial mortgage market.

Commercial Mortgage Loans can be recourse or non-recourse in design. In a typical recourse loan, the borrower is personally liable for the loan in the event that the loan is foreclosed and the funds are not sufficient to pay the loan balance in full. In non-recourse loans, the property is the collateral and the borrower is not personally liable for the mortgage debt. In typical non-recourse loans, a provision called “bad boy clauses” is part of the loan documents that state that in the event of fraud, willful misrepresentation, gross negligence, criminal acts, misappropriation of property income, and windfall profits insurance, the lender may hold the borrower (s) personally liable for the mortgage debt.

Lenders in commercial mortgage negotiations understandably prefer recourse loans when borrowers would prefer non-recourse loans. In the underwriting process, the lender and borrowers work to create a loan that meets the needs and goals of both parties, and if a deadlock occurs, the loan is not issued.

The world of commercial mortgages offers investors the possibility to participate in a market that can have attractive returns, principal security through lien positions on real estate assets and durations (from 12 months to 5 years) that are acceptable for the most. Building ongoing monthly interest through holdings like commercial mortgage notes is attractive to both consumers and institutional investors.

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