Transcript Chapter 20 Commercial Real Estate Finance

Chapter 20
Commercial Real Estate
Finance
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
Major Topics
 How does commercial real estate finance
differ from residential?
 What affects the availability of commercial
property financing?
 Who are the major providers of commercial
property mortgages?
 What is the CMBS market and how does it
provide mortgage money?
 How do lenders underwrite commercial
property? Assess risk?
 How do borrowers determine where and
how to finance a property?
 How is the internet changing the business?
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
Introduction
Distinctions between financing Commercial
properties and Residential financing:
1. Commercial financing transactions are less
standardized
2. Transaction amounts are large
3. Loan terms are much shorter
4. Loan documents are customized to the
transaction and are heavily negotiated
5. Underwriting emphasis is on the property’s
income and value
6. Commercial property loans are not subject
to consumer protection laws
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
Introduction (Contd.)
7. Detailed and lengthy loan submissions are
specifically prepared for each transaction
8. Prepayment ability is limited
9. The loan approval process is lengthy
Commercial Borrowers and
Lenders
Individual real estate investors and
partnerships
Corporate users of real estate
Real estate developers
Large institutional owners
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
Sources of Debt Funds
 Commercial banks are clearly the most
important source of commercial property
loans
 Commercial mortgage backed securities
(CMBS) have become the second most
important source followed by life
insurance companies
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
Process of Securing Commercial Property
Financing
Step 1: Complete the Financing Loan
Application Package
Step 2: Package Submission and Solicitation of
Quotes
Step 3: Loan Application
Step 4: Underwriting
Step 5: Loan Committee Approval
Step 6: Commitment Letter
Step 7: Due Diligence and Closing Process
Step 8. Loan Closing and Funding
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
Mortgage Underwriting
 Loan to Value Ratio (LTVR)
 Debt Coverage Ratio (DCR)
 Break Even Point
 Evaluation of NOI (Completed
Property)
 Evaluation of NOI (Property to be
built)
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
New Directions: Commercial
Mortgage Backed Securities
 In a CMBS the securities are separated into
different classes referred to senior and
subordinated tranches
 The tranches are rated according to the
priority of claims on the cash flow from the
properties securing the issue
 Those investing in the subordinate classes
of the securities will receive a higher
interest rate to compensate for their risk
 The Z tranche is the residual tranche
receiving the lowest priority of property
repayment proceeds
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
The Rating Process
 Probability of Default based on:
 Debt Service Coverage Ratio (DSCR )
 Loan to Value Ratio and cross
collateralization
 Property type and geographic location
and market conditions for each property
type and geographic market
 Expected cash flow volatility (lease
structure, market conditions or tenants)
 Track record of players
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
CMBS Advantages and Disadvantages
for Borrowers and Lenders
 Advantage to lender: the sale of mortgages
originated allows lenders to reduce and
reallocate their direct portfolios of single
mortgages
 Disadvantage to borrowers: significantly
higher transaction costs such as investment
banking fees, rating agencies and other
professional services
 Conduits – entities that originate or
purchase loans and hold them until they
form a pool that is large enough for a CMBS
transaction – are more “user friendly” for
the borrower in that the borrower has no
involvement in the securitization process
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
The Securitization Process for
a CMBS Mortgage
 Step 1: Loan Production/ Origination/
Underwriting
 Conduits
 Government Agencies
 Private Portfolio Loans
 Institutional Portfolio Loans
 Step 2: Mortgage Documentation
 Step 3: CMBS Issue Underwriting
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
The Securitization Process for
a CMBS Mortgage
 Step 1: Loan Production/ Origination/
Underwriting
 Conduits
 Government Agencies
 Private Portfolio Loans
 Institutional Portfolio Loans
 Step 2: Mortgage Documentation
 Step 3: CMBS Issue Underwriting
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
Securitization Process
(Contd.)
 Step 4: Issue Structuring
 Step 5: Credit Enhancement
 Step 6: Closing
 Step 7: Distribution
 Step 8: Servicing
 Step 9: Trading CMBS Issues
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner
END
“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner