Your “amortization” is the distribution of loan repayments into a series of cash flow installments. Each repayment pays a portion of both your principal balance and your accrued interest. When you obtain a commercial mortgage, all your repayment details are set out in an amortization schedule (which is the schedule of loan payments over the life of the loan). Your amortization schedule factors in the amount of principal and the amount of interest that comprise each payment until your commercial loan is paid off at the end of the loan term. In some instances, the loan terms and amortization schedule cover the same time period – allowing you to pay off the mortgage with your last repayment. Unlike residential mortgages, however, commercial loans often have an amortization period that is longer than the term of the loan. With a longer amortization period, borrowers make repayments during the loan term that reflect the payment amount as if the loan were to be paid off over the entire length of the amortization period. For that reason, when a commercial mortgage has an amortization period that extends beyond the loan term, the loan is usually paid off with a final balloon payment.

Whether the financing is for a purchase, bridge loan, or refinancing, appraisals are necessary for lenders to confirm that the market value or purchase price of the property is accurate. Appraisals also help lenders determine if there are problems with the property that need to be factored into the loan amount or could affect the success of the transaction. Appraisals for commercial properties can be expensive. They are ordered by the lender but usually paid for by the borrower. Since the borrower does not want to have to pay for more than one appraisal, most loan applicants will wait until the lender has issued an acceptable term sheet before paying for the appraisal.

To sum things up, non-recourse loans are harder to get, but are very much the norm in the market of commercial loans of $5–$10+ million. There is one caveat: most non-recourse loans come with bad boy carve-outs, which give the lender full recourse if a borrower is negligent or does anything fraudulent. This could be a borrower materially misrepresenting their financial strength to the lender, intentionally declaring bankruptcy, failing to pay their property taxes, or failing to maintain required insurance coverage. These carve-outs can quickly convert a non-recourse mortgage loan into a full-recourse loan.

A balloon payment occurs when the amortization schedule is longer than the loan term. To use an example, let’s say a borrower has a $1million commercial loan with a term of 7 years at a 7% interest rate, with an amortization period of 30 years. The borrower would repay the loan for seven years at an amount based on the loan being paid off over 30 years – so the borrower would make monthly payments of $6,653.02 for a full seven years. At the end of the 7-year term, the borrower would make one final “balloon” payment of the entire remaining balance on the loan. A final balloon payment of $918,127.64 would pay off the loan in full. The larger the differential between your loan term and your amortization period, the larger the balloon payment you will need to make at the end of your loan term. That can potentially put you at risk or of needing to refinance the property.

Capital expenditures, or CapEx, are typically large investments in a property that will extend its economic life. For instance, replacing the windows in a building or installing a new heater would usually be considered CapEx, as these building elements may need to be replaced someday, but maybe not for a significant period-of-time. Other common capital expenditures include replacing flooring, electrical systems, plumbing systems, and ductwork. Funds that are used to upgrade the property to make it more valuable also count under CapEx.

Commercial property loans are subject to closing costs once the transaction is finalized. The closing costs cover legal fees surrounding the transfer of assets and all associated paperwork. Closing costs can be expensive but are negotiable between the buyer/borrower and seller. As a buyer, you can (and should) have it stated in the sale contract which party will be responsible for each cost at closing such as title insurance, deed stamps, surveys, and settlement fees. It is important to note that lenders are not restricted in what they can collect from borrowers at closing. Lenders have a high level of discrepancy as to how much they charge administration fees, points, and so on. Because of this, it is critical all fees should be reviewed and negotiated well in advance of closing, and that you work with experts (i.e., Realty Yield) who can connect you to the right loan offer for you.

A multi-family bridge loan is a financial tool used by commercial property owners to bridge the gap between the moment they get the loan and the moment they can do what they want to do with the property. Multi-family and commercial real estate bridge loan terms are usually between 3 months and 3 years. The most common uses of bridge loans are to quickly purchase a property when all cash is not an option. Other types of loans are often heavily based on the income a property generates and detailed analysis. Because of this lack of required analysis, a bridge loan can close much faster than a traditional loan. This however comes at a trade-off, interest rates on bridge loans can be triple or quadruple market rates for conventional financing. Another use of abridge loan for a multi-family or other commercial property, would be for a substantial rehabilitation and stabilization prior to getting conventional multi-family financing. The bridge loan would be used to keep the property financed while finishing up the necessary upgrades and then leasing up the property. This can apply to most property types such as multi-family, retail, office, etc. Each borrower may have unique circumstances, but bridge loans requirements remain consistent at around 65% of the property value and have a payoff date that is usually less than three years. 

Debt Coverage Ratio, or DCR, also known as Debt Service Coverage Ratio (DSCR), is a metric that looks at a property’s income compared to its debt obligations. Properties with a DSCR of more than 1.0 are considered profitable, while those with a DSCR of less than 1.0 are losing money. DCR/DSCR is an essential part of the decision-making process when a commercial or multi-family lender decides whether to issue a loan. In general, if a property has an abnormally low DCR/DSCR, they will have difficulty paying back their loan on time. Most lenders like borrowers to have DSCRs of at least 1.15-1.25x. In addition, “safer” property types can also qualify for loans with lower DCRs. For example, while more risky property types such as hotels or motels might need a 1.30-1.50x DSCR to get funding, traditional multi-family, or commercial properties (think apartment buildings or shopping centers with an anchor tenant) would only need around a 1.20x DCR. The DCR/DSCR formula: Net Operating Income (NOI) / Debt Obligations. Despite the apparent simplicity of the formula, an investor will need to make sure they have the correct numbers in-order-to calculate an accurate debt coverage ratio (DCR) for a property. Global DCR is when a DCR/DSCR formula factors in a borrower’s personal income and personal debts into the equation. This is typically only done in the case of smaller owners, as well as small multi-family and commercial real estate investors, as lenders want additional reassurance that these individuals are financially responsible and likely to pay back their debts on time. If a borrower has a high income and little personal debt, using global DCR will benefit them, while if they have lower income and higher personal debts, it will make it more difficult for them to obtain commercial or multifamily real estate financing. 

Equity multiple is one of the most important metrics in commercial and multi-family real estate and is used to compare the amount of cash a property generates to the amount of equity invested. When looked at alongside IRR (internal rate of return), and cash-on-cash returns, equity multiple can provide an excellent determination of whether a property is likely to be a profitable investment. A property’s equity multiple can be calculated by taking a property’s total cash distributions over a specific time period and dividing it by the total equity an investor has put into the property. It can be calculated by using the formula below: Equity Multiple = Total Cash Distributions / Total Equity Invested. For instance, if the amount of money invested in an apartment property totaled $500,000, and the total cash distributions (after the sale of the property) equaled, $1,000,000, the equity multiple would be ($1,000,000 / $500,000 = 2). 

Equity multiple is more accurately compared to a property’s cash-on-cash returns, as this metric also compares the amount of cash a property has generated over a specific period-of-time. In most cases, a cash-on-cash is reported as an annual percentage, while equity multiple a number is usually calculated over a period of several years. The cash-on-cash returns formula is: Net Operating Income (NOI) / Total Cash Investment. So, for example, a property would have a cash-on-cash return of 10.0% if the Net Operating Income was $100,000 and $1,000,000 was invested ($100,000 / $1,000,000 = $10.0%), assuming the property has fully been purchased in cash. If the property is purchased with a loan, only the down payment will be counted as the total cash investment.  

Internal Rate of Return, or IRR, is commonly compared (and sometimes confused with) equity multiple, as they are both similar metrics that attempt to determine the profitability and effectiveness of a real estate investment. Equity multiple focuses on the cash that a property generates over a specific time-period, while IRR looks at overall return for each dollar invested into a property. While IRR uses time value of money (TVM), equity multiple does not. 

Commercial mortgage lenders offer rates that are either “Fixed” for the entire term of the loan, or “Floating". A floating rate (also known as a variable or adjustable rate) may move up or down depending on fluctuations in the rest of the market, or along with changes in a particular index. Often, this choice is left to the Borrower, and many lenders offer both Fixed and Floating rate loans for a variety of property types.

Gross potential rent, or GPR, is a calculation of the maximum amount of rental income that a landlord could generate from a property. GPR assumes that a property has 0% vacancy and that there are no rental payment issues. In addition, gross potential rent is based on market rent, which is the average amount of rent that tenants pay for similar properties in the same geographic area. For example, if a property has a 12-units, each which has a market rent of $1,000 a month, the property will have a monthly GPR of $12,000 and an annual GPR of $144,000, assuming that there is 100% occupancy.

A property’s Gross Rent Multiplier, or GRM, is one of the best ways to quickly calculate its profitability compared to similar properties in the same real estate market. Another variant of GRM is Gross Income Multiplier (GIM), which is used when a calculation also incorporates non-rental sources of income, such as vending machines or coin-laundry machines. Gross Rent Multiplier = Property Price / Gross Rental Income. So, for example, if a property is selling for $2,000,000 and it produces a Gross Rental Income of $320,000, the GRM would be: $2,000,000 / $320,000 = 6.25.

Commercial mortgage rates fluctuate with market conditions but are generally tied to the indices (or “indexes”) set by the federal government– such as the LIBOR, Prime, Swap, and Treasury indices. Most of these Indices also have multiple time frames that will also be chosen by your lender, such as 6 Month LIBOR, 10 Year Treasury, etc. It will also come with an additional “spread” of basis points over the designated term of the loan. Spreads are determined by the lenders in Realty Yields loan network and vary depending on the selected loan product and term. They are also affected by factors such as the property type, property class, location, income, and borrower credit. Generally, spreads range between 200 and 250 basis points (2.0% to 2.5%). For example, a lender may offer you a Freddie Mac multifamily loan with a spread of 225 basis points over the 10 Year Treasury Index rate of 2.37%. That means the effective rate would be 4.62%, based on 2.25% + 2.37%.

Certain commercial mortgages may be available as I/O or “interest only” loans. These are loans in which the borrower only makes payments on the interest of the loan for a set period-of-time, starting at the beginning of the loan’s term. During that period, the borrower does not need to make payments on the principal amount. After the set time period has elapsed, the loan is amortized to require payment on both the principal and interest. I/O loans have pros, cons, and risks. Some property owners may find them appealing as they look to manage cash-flow while they reposition, rehabilitate, or turn units early on since “I/O” loans have lower payments up front. But depending on the amount of capital borrowed, the risk of default could be higher. Monthly payments become considerably larger once the interest only payment period ends, since none of the principal balance has been paid down yet.

A property lien is a legal right to the property that guarantees the underlying financial obligation for the investment property – i.e., the borrower’s obligation to repay the loan. If that obligation is not met, the parameters of the lien dictate that the lender can seize the property that is serving as collateral for the commercial mortgage. The execution of a lien also means that the underlying property cannot be sold by the owner without the consent of the lien holder. The issue of lien position relates to what happens if you, as a borrower, default on your commercial property loan. The lien position is especially important to understand in bridge loans, which borrowers often seek out to help them satisfy short-term capital needs and which (for lenders) can pose a high risk of default. In the event of default, the lien position determines who has a right to receive proceeds from the ultimate sale (or “liquidation”) of the property. In most cases, for commercial loans up to $5M, the lender will require a 1st lien position on the property. For construction loans, the lender may approve a 2nd lien position. Most lenders in Realty Yield’s network primarily specialize in first lien position mortgages.

Loan constant, also known as mortgage constant, is a percentage which compares the entire amount of a loan by its annual debt service. In addition to DSCR, LTV, and debt yield, loan constant is an important metric that lenders use to determine a property’s suitability for a commercial or multi-family loan. To determine a property's loan constant, a borrower will need to know information including the term, interest rate, and amortization of a loan. In general, loans with a lower loan constant are generally more profitable for borrowers. The formula for Loan Constant: Annual Debt Service / Loan Amount. For example, a 20-year, fully amortizing loan of $2,000,000 with a 5% interest rate would incur $158,389 in payments each year, with a loan constant of 7.9% ($158,389 / $2,000,000). Comparing a property’s loan constant with its capitalization rate is a valuable calculation when assessing how much leverage to implement because it will have a significant impact on the cash-on-cash return. For example, if we take the property in the example above, and its generating $170,000 a year in net operating income, its capitalization rate would be 8.5% ($170,000 / $2,000,000). Hence, since the loan constant of 7.9% is lower than the capitalization rate of 8.5%, the borrower is making money from the borrowed money (i.e., positive leverage). In this case, it would most often be prudent for the borrower to secure the highest loan amount available. While the loan constant is a valuable metric, it cannot be applied to adjustable or variable rate commercial mortgages since the constant change in interest rates makes it impossible to determine an accurate loan constant. For similar reasons, the loan constant cannot effectively be applied to interest-only (I/O) loans.

Fees charged by commercial mortgage lenders may include application fees, points, loan administration and underwriting fees, which cover the costs of underwriting borrowers’ loans. Fees are typically paid when the loan closes, though an application fee is often charged earlier in the loan process. If you work with a commercial mortgage broker, he or she may charge an application fee as well – so borrowers should closely scrutinize all fees charged to them in their property loan agreements and should ask about fees before choosing to work with a commercial mortgage broker. Application fees charged by a commercial real estate lender sometimes cover the appraisal costs(though those may be charged to the borrower separately). In general, fees can vary broadly depending on the loan type and size of the property and borrowers should be careful to compare fees among offers from multiple lenders. 

Your loan term is the amount of time it will take you to payoff your commercial mortgage according to the conditions established between you (the borrower) and your lender. The length of the loan term will affect the interest rate that a commercial lender will charge you as a borrower for the mortgage on your investment property. The terms of commercial loans typically range from 3 years to 30 years. In general, you will pay a higher interest rate if you seek a longer-term loan. For example, you will likely pay a higher interest rate on a 15-year loan term than on a commercial mortgage with a 7-year term. The loan term and amortization schedule offered to you by a commercial lender translate directly to how much you pay with each loan payment; and how long you pay back your commercial mortgage.

This ratio is used in commercial mortgage finance and multi-family property financing to determine the ratio of a particular debt (perhaps a first mortgage) relative to the value of the collateral (in this case a multi-family or other commercial property). If a borrower owns a property worth $5 million and is looking to refinance a first mortgage for $3.5 million, the LTV is 70%. Lenders use this figure to determine their level of risk and borrower leverage in a transaction. The lower the LTV, the lower the risk. The formula for LTV (loan-to-value): LTV = Loan Amount / Total Value.

Mezzanine financing is a capital resource that sits between (less risky) senior debt and (higher risk) equity that has both debt and equity features. Companies use mezzanine financing to achieve goals that require capital beyond what senior lenders will extend. In many cases, investors or developers looking to maximize their IRR also need to maximize leverage, as the cost of equity is often more expensive than non-recourse debt. In other situations, they simply need more leverage to keep liquidity available for other opportunities. When looking to build your capital stack, your first option should be mezzanine financing and preferred equity. While multifamily and commercial mezzanine lenders often prefer to have a recorded second mortgage as security, a pledge of stock is also an option for securing your mezzanine financing; this is commonly referred to as preferred equity. Although there usually is not any true equity, the security itself is considered equity. Therefore, collateral is typically the only true difference between mezzanine loans and preferred equity.

If a borrower takes out non-recourse commercial financing, they are not personally liable if they default on their loan. Instead, the lender may only repossess and sell the property in-order-to recoup their losses. Non-recourse loans are the opposite of recourse loans, which allow a lender to seize and sell a borrower’s personal property. Most bank loans, mini perm loans, and commercial construction loans are typically recourse loans, while CMBS financing, Fannie Mae and Freddie Mac multifamily loans, mezzanine loans, life company loans, and HUD multifamily loans are generally non-recourse financial instruments.

“Points” may be part of your loan parameters. Points may be charged by lenders, brokers, or other intermediaries as a way to be paid for their work with your loan. Points are paid at closing and represent a fixed percentage of the loan balance. “One point” equals one percent of the loan amount.  

The structure of preferred equity in commercial real estate and multi-family lending and investing (sometimes called junior equity) can get complex but the idea behind it is simple. Preferred equity is often reserved for larger commercial real estate deals over $10 million and sits on top of debt in the capital stack. Most often it will sit on top of a first and second lien and is therefore junior to them (which is perhaps where the term junior equity comes from). Preferred equity and mezzanine financing can help borrowers leverage a transaction as high as 90%+ LTV. Preferred equity is there to reduce the capital requirements of the borrower but is typically available at a high cost (usually a substantial amount of equity in the property) and is mostly available on substantial value-add transactions, construction (development) or special properties (perhaps historical). Quite often mezzanine loans may be structured to include a preferred equity component. Preferred equity is also used in commercial real estate and multifamily finance in the case of senior lenders (first lien holders), that do not allow for subordinate debt. The borrowing entity, after obtaining a preferred equity investment, usually maintains all control over the property, but in the event of a default the preferred equity investor would take over in managing the commercial real estate. This is usually done by doing a UCC foreclosure on the membership interest of the LLC that owns the piece of commercial real estate to take control of the company, and therefore the project.

Prepayment Penalties can come in many forms, so borrowers are wise to pay close attention to these specifications as they select the right commercial property loans for their needs. For example, some banks or other lenders may charge a penalty for any prepayment - regardless of the size of the remaining balance or the remaining term of the loan. That said, most lenders will not charge a penalty if the prepayment is less than 10% of the original principal or may waive the penalty in the event the property is sold, or the borrower originates a new loan from the existing lender. The penalty may take the form of a set fee or set percentage of the remaining loan balance. More often, however, the commercial mortgage will include a more complicated fee structures for the penalty that will vary in accordance with time. One example is a 5-4-3-2-1 structure, in which 5% of the remaining balance is the penalty if the loan is prepaid during the first year of its life, 4% in the second year, 3% in the third, and so on. This recognizes that the longer the remaining term of the loan the more value it likely has to the bank and the greater penalty necessary to compensate the lender.

Because of the increased risk of non-recourse financing, commercial lenders often only accept certain property types and classes for non-recourse financing. For example, a class A office or multi-family property in a major MSA (i.e., Portland or Seattle) may get a non-recourse loan, while a class B/C retail property in a tertiary market is unlikely to qualify. Property income (both past and present) are also determining factors, as well the requested amount of leverage. In general, non-recourse loans typically have a higher interest rate than their recourse counterparts. Non-recourse commercial mortgage loans are also generally only available to borrowers that are strong financially. In these cases, a default is significantly less likely because the borrower has the financial means to make sure that the property’s income is used for the property. Commercial mortgage lenders will also require an experienced borrower for making a non-recourse loan.

Commercial mortgage rates vary by property type, location, tenant mix, LTV, loan term and amortization period, and other factors (including complex concerns like debt service coverage and deal sponsorship). Each of these are carefully considered in the underwriting of each individual loan. Rates also vary widely depending on type of lender: Government lenders and banks typically offer the lowest but have the most stringent underwriting procedures and guidelines. Rates can also go up or down depending on how the lender sources their capital: Private lenders (which are supplying their own capital) tend to offer higher rates but have significantly more flexibility in who they make loans to. All commercial rates are based on indices but are also uniquely tailored to the needs, concerns, and objectives of individual commercial borrowers. Once you submit your mortgage needs to Realty Yield, our experts will help connect you to a mortgage lender with the right interest rate and terms to meet your expectations. The lenders in our network specialize in analyzing property financials and calculating how to maximize returns for borrowers. For “A” quality borrowers, interest rates often begin at around 3.3% (as of 1/2021). For variable rate loans, rates are typically expressed as a base rate plus a spread over the index rate. The base rate plus the spread indicates the starting rate for the loan. For example, a loan priced as “Prime +1%,” when Prime – a type of index rate – is at 3.25%, would have a starting rated of 4.25%. Every time the Prime rate index moves up or down, the rate on the loan will also go up or down by the corresponding amount. For fixed rate loans, rates are typically expressed simply as a percentage – for example, 4.25%. The lender will have settled on this rate based on their analysis of the index and spread, but the rate will not change during the duration of the Loan Term.

When a commercial property has a floating interest rate loan, it may come with a “cap” (or maximum limit) on the highest allowable interest rate during the term of the loan. It also may or may not come with a “floor” limiting the lowest allowable interest rate. An interest rate cap helps minimize the risk for borrowers on a floating rate commercial property loan. Borrowers usually select floating-rate property loans with variable interest rates during periods when interest rates are very low; if the rates get even lower, the borrower benefits. But the borrower may end up with vastly increased financial risk if interest rates rise rapidly or significantly during the loan term. Capping the rate decreases the risk of default. The interest rate cap may apply during a specific period of the loan – such as the first 1-3 years – or for its entire lifetime. An interest rate “floor” works the opposite way, ensuring that the loan can meet the lender’s return expectations even if rates go down significantly.

Recourse loans are loans that provide the personal guarantee of the person borrowing the money or the person(s) behind the entity borrowing the money. Recourse can benefit the borrower in that if he feels confident about putting his personal name and personal assets behind the loan, he can sometimes achieve better loan terms, but more-often-than-not, recourse is required when a borrower or borrowing entity is not strong enough on its own, or if the property itself does not fall into a category that makes it conventional. Either way, recourse allows greater security for the entity lending the money. With recourse loans, in the event of a default, in any capacity, usually in the form of falling behind on loan payments, the lender can seek financial damages from the borrower directly, so that if the investor does take a loss on the property it can go after the borrower individually for the balance of the money owed. This can include repossessing personal property, or even garnishing wages from a borrower’s bank account.

A trailing twelve months, T12, or TTM, is a financial statement that shows a multi-family property’s previous twelve months of operations. A T12 is generally used for apartment buildings and other types of multi-family properties, but not for other types of commercial real estate, such as retail or office properties, as tenants for these types of properties typically have leases that extend beyond twelve months. A property’s T12, along with its rent roll and T3 (trailing 3-month financial statement) are some of the most important forms of documentation that a borrower will need to show a lender. A T12 can generally be calculated by looking at a property’s financial statements, such as balance sheets and income statements.

In large loans, the prepayment penalty may include a yield maintenance provision. This penalty fee structure is intended to fully compensate a commercial mortgage lender for any lost interest between what the present rate is on the loan, and what the new rate is given the prepayment amount and the current interest-rate environment for the remaining term on the loan. A large loan may also include a “defeasance” provision. As its name suggests, defeasance is a method of reducing fees in a commercial mortgage prepayment scenario: It allows borrowers to repay the loan by substituting the mortgage, and its stipulated interest rate, with a portfolio of securities (usually U.S. Treasury bonds). However, both yield maintenance and defeasance provisions are only typical for large loans and rarely (if ever) affect loans under $5M.