Commercial real estate (CRE) is nothing but an income production used solely for the purposes or business such as office complexes, hotels and apartments and retail centers. It can also be used for financing that is inclusive of the procurement, development and building of these properties. All of this can be typically get done by the CRE; the mortgage loans secured by commercial liens rather than any residential property.
Individuals vs. Entities
While the residential mortgages are made available typically to the individual borrowers, the commercial real estate loans are usually offered to the business entities like developers, corporations, funds, trusts and partnerships. It is possible for an entity not to have a track record of finances for which the lender may enquire about the entity owners or principals for loan guarantee. This will have the lender provided a credit history or a financial track record that could be recovered from a particular person at the time of loan default.
Schedules for Loan Repayment
This is a residential mortgage being a type of amortized loan that demands the repayment of the debt is in regular installments over a particular period of time. The extremely popular and well known product of the residential mortgage is the 30-year fixed-rate mortgage. The residential buyers can also opt for the other options in the mortgage products like 25-year and 15-year mortgages. Longer the amortization period, smaller will be the monthly payments and higher will be the total cost of interest over the complete cycle of loan period. On the other hand, shorter the amortization period, bigger will be the monthly payments and lesser will be the total cost of interest. The duration of term of the loan and the period of amortization, both, will affect the rate charged by the lender. The credit strength of an investor the terms and conditions associated may be negotiable.
It is figure that is capable of measuring the loan value against the property value. LTV is calculated by dividing the loan amount by the lesser purchase price or appraised value of the property. For commercial real estate as well as the residential loans, the borrowers having lower LTVs are considered to qualify for additional favorable rates of finances in comparison to those with higher LTVs. This is because they tend to have additional equity in the property which is equivalent to lesser risk as per the lender.
Debt-Service Coverage Ratio
The commercial lenders consider the debt-service coverage ratio (DSCR) that compares a net operating income (NOI) annually, on any property in against with an annual mortgage debt service inclusive of interest and principal. This deals with the measuring of property’s ability to produce its debt. As per the formula, “DSCR is calculated by dividing the NOI by the annual debt service.” Lower DSCR might get accepted for the loans having shorter periods of amortization and also for the properties having constant cash flows. Higher DSCR ratios might suit the properties having volatile cash flows like hotels that lack the long-term and more predictable leases for tenant, which is common to rest of the types of commercial real estate.
Interest Rates and Fees
The rate of interests levied on commercial loans is often higher as compared to the residential loans. Moreover, the commercial real estate loans generally involve fees adding to overall cost of loan comprising of legalities, loan application, appraisal, loan origination and survey fees. Few costs are supposed to be paid right before the loan approval or rejection while others apply yearly.
Prepayment clause may restrict commercial loans in few areas. This is designed in order to protect the anticipated yield by the lender on the loan amount. If the settlement of the loan is done by the investor before its date of maturity, he/ she will have to pay the penalties foe prepayment. As per the clause, there exist four types of primary “exit” penalties namely prepayment penalty, interest guarantee, lockout and defeasance. These come into the picture when the loan is paid off before time.
The terms of prepayment are demonstrated in the loan documents. These terms could be negotiable in accordance with the other terms of loan in commercial real estate loans. So, it is very much important to understand the various options that could be fetched ahead of time before you pay off the loan early.