Commercial Mortgage

Definition:

Commercial mortgage is a type of loan made by putting real estate as guarantee to secure repayment.

This is alike the residential mortgage, but in commercial mortgage the security is a commercial building but not a real estate property. Generally these types of loans are taken by businesses rather than individual borrowers.

In this type of loan evaluation of trust value of the business is more problematical compared to residential mortgages because the borrower may be a partnership incorporated business or a limited company.

Commercial mortgages may be nonrecourse. It means that in the event of the borrower’s default repayment, the lender can only seize the guarantee but cannot further claim the remaining deficiency. There are two reasons for this:

Many laws prevent the creditor from going after the borrower for repayment or for any deficiency.
Mortgages planned for sale as bonds issue utmost priority to constantly receiving some amount of money as income and require a statement which shows the lender to take the property immediately inspiteof bankruptcy proceedings the borrower might be going through.

Term:

Most of the commercial mortgage loans in United States require the borrower to make a monthly payment and also require a balloon payment.

So there are two points to the term of a commercial mortgage loan:

  • The length of the time allowed until balloon payment
  • Amortization

The length of the loan varies from a period of few days to as big as 30 years.
If a loan has a 30 year amortization but a 10 year term it is referred to as a 10 year balloon with a 30 year payment schedule.

For example, let us suppose a $15,000,000 loan at 8% interest with a 30 year amortization schedule and 10 year term with monthly payment. The amount to be paid will be $110,065 per month for a 360 day accrual.

Applications:

Commercial mortgages are used for:

  • Acquiring land
  • Commercial properties
  • Expanding existing facilities
  • Refinancing existing debt
  • Guarantee standards:

Commercial mortgages are designed to be underwritten based on the part of the property being mortgaged, rather than the credit element of the borrower. For this the lenders want the property to be owned by a single asset entity such as a corporation or LLC. This gives the lender the right to foreclose on the property in the event of default even if the borrower went to bankruptcy. This is known as “bankruptcy remote”.

In the case of residential mortgage it is difficult for the lender in selling a property if the bankruptcy case is still pending.

Lenders also require a debt service coverage ratio. This ranges from 1.1 to 1.4. This ratio is nothing but net cash flow to the debt service.

For example, if the owner of a shopping mall receives $300,000 per month from tenants and pays $50,000 per month in expenses, the lender gives a loan that requires monthly payments up to $227,273.

This is nothing but a 1.1 debt cover.

($300,000 - $50,000 )/1.1 = $227,273

Lenders also consider Loan to Value. This is a calculation which expresses the amount of a mortgage as a percentage of the total appraised value.

Example:

If a borrower wants $6,000,000 to purchase an office worth $10,000,000 then the LTV ration is $6,000,000/$10,000,000 = 60%
Commercial mortgage LTV are between 55% and 70%.