Transcript CHAPTER 2 BASIC VALUATION CONCEPTS

COMMERCIAL PROPERTY
FINANCING
LEARNING OBJECTIVES
 Discuss the most common types of long-term
commercial mortgages and their common
provisions.
 Discuss financing structures that allow
lenders to participate in the property.
 Discuss the advantages and disadvantages of
financial leverage.
COMMERCIAL PROPERTY
FINANCING
LEARNING OBJECTIVES
 Identify and explain the items commonly
included in a loan submission package.
 Identify the elements of the loan application
that lenders focus on in making funding
decisions.
 Discuss the typical sequence of financing for a
new development.
COMMERCIAL MORTGAGE
MARKET CHARACTERISTICS
 The primary market is dominated by commercial
banks and life insurance companies.
 In recent years, the size of the CMBSs market has
grown dramatically.
 Commercial mortgages are typically 5- to 10years, and often include a ballon payment.
 Commercial mortgages are often nonrecourse
loans.
COMMON TYPES OF
PERMANENT MORTGAGES
 Balloon Mortgages
 Common Loan Provisions
 lock-out, prepayment, and yield
maintenance provisions
 Floating Rate Loans
 Installment Sale Financing
Example Commercial Mortgage Loan Terms
Rates – Fixed
Rates – Floating
Spreads over Treasuries on
Fixed Rate Loans
Spreads over LIBOR on
Floating Rate Loans
Maximum LTVR
Minimum Debt Service
Coverage
Loan Term
7.25-8.15%
6.60-7.60%
125-176 bp
100-200 bp
75%
1.15-1.20
1-10
PERMANENT MORTGAGES
WITH EQUITY PARTICIPATION
 Participation Mortgages
 income kickers
 equity kickers
 contingent interest
OTHER EQUITY
PARTICIPATION
ARRANGEMENTS
 Joint Ventures
 Sale-Leasebacks
THE BORROWER’S DECISION
MAKING PROCESS
 Two basic reasons real estate investors use
borrowed funds:
 to increase the size of their purchase
(affordability), and
 to magnify their expected rate of return
(leverage).
 Positive and Negative Leverage
The Effect of Leverage
 Increased Financial Risk
 Increased Variability of Returns.
 effect on before- and after-tax cash flows.
 effect on before- and after-tax equity
reversion.
The Effect of Leverage
=
Initial LTVR
NOI in yr. 1
Debt Service
BTCF
Initial Equity
BTCF/Initial Equity
Mean IRR
0%
$1,272,500
---1,272,500
13,375,000
9.51%
10.68%
60%
80%
$1,272,500 $1,272,500
683,773
857,038
584,727
415,462
5,350,000 3,375,000
10.93%
12.31%
14.58%
17.84%
THE LOAN SUBMISSION
PACKAGE
 Loan Application
 Property Description and Legal Aspects
 Cash Flow Estimates
 Appraisal Report and Feasibility Study
LOAN UNDERWRITING
 The Property and Borrower
 Property Type, Quality, and Location
 Tenant Quality and Lease Terms
 Environmental Concerns
 Borrower Experience and Resources
The Maximum Loan Amount
 The Loan-to-Value Ratio:
LTV = Vm / Vo
 The Debt Service Coverage Ratio:
DCR = NOI / Debt Service
 The Break-Even Ratio:
BER = (OE + DS) / EGI
ACQUISITION, DEVELOPMENT, &
CONSTRUCTION LOANS
 Land Purchase and Development Financing
 Construction Financing
 take-out commitments
 gap loans
 open-ended loans
 mini-perm. loans