Commercial Mortgage Commentary – CMLS Mortgage Analytics Group

Making News

Overnight Rate
In late October, the Bank of Canada (“BOC”) announced the third 25 bps rate hike this year, which brought the overnight target rate to 1.75%. The increase comes after continued strength in economic figures and the negotiation of the “new NAFTA” trade deal with Mexico and the U.S. This pushed the prime rate of major Canadian banks to 3.95%.


GOC Yields
Spread premiums between the Government of Canada (“GOC”) 3, 5, and 10-year term bond yields remain extremely tight. Through Q3/18, the premium between 3-year and 10-year tightened by 4 bps, while the premium between 5-year and 10-year remained unchanged.

Investments
In Q3/18, Telus sold its Vancouver headquarters, Telus Garden, to a partnership of investors represented by Regina-based Greystone Managed Investments for an undisclosed amount. The property was built as a joint-venture by Telus and Westbank Corp. for $750 million and consists of an office tower and residential building in Downtown Vancouver. Telus is expected to generate approximately $170 million in profit on the sale.


Commercial Mortgages

Lenders and borrowers have maintained balanced supply and demand for the 5th straight month with commercial mortgage spreads staying flat. 5-year deals are pricing 145 bps to 160 bps over GOC bonds for top quality assets, while 10-year spreads are pricing at a 10 bps premium for similar risk. The liquidity premium of commercial mortgage spreads over BBBrated corporate bonds remained generally unchanged since our last report with the premium down slightly from 64 bps to 62 bps as a result of a slight increase in corporate spreads. This moves the liquidity premium away from the long-term average of 70 bps.


CMBS

The CMBS market continues to be challenged by unattractive profitability due to tightening commercial mortgage spreads relative to CMBS bonds. Recent weighted average breakeven mortgage spread for new CMBS issuance was approximately 225 bps and with current spreads around 190 bps, the prospects of profitability falls short by 35 bps. Until the commercial mortgage spreads move past the CMBS breakeven point, new issuance activity is expected to be thin.

Senior Unsecured Debt

In Q3/18, senior unsecured debt issuance slowed to $625 million, down from $1.65 billion in Q2/18. However, cumulative 2018 issuance is up 27% on a YTD basis and makes up 86% of the total issuance in 2017. Since our last report, Crombie REIT issued a $75 million, 2.9- year note with a 170 bps spread. Overall, spreads on BBB-rated unsecured debt decreased through Q3/18 to 145 bps. For now, spreads on unsecured REIT debt continue to receive cheaper investor dollars compared to conventional commercial mortgages with a difference of only 10 bps at the end of Q3/18.

CMHC

Spreads on multi-family CMHC-insured loans remained stable since our last report with spreads ranging between 80 bps and 105 bps over GOC on 5-year terms and between 85 bps and 110 bps over GOC on 10-year terms. This is partly due to the relatively unchanged spreads on CMHC-backed Canada Mortgage Bonds (“CMB”). 5-year CMB spreads only decreased 3 bps to 28 bps and the 10-year CMB spreads remained flat between July and September.


High Yield

In Q3/18 the British Columbia Securities Commission (BCSC) announced it will not be renewing the exemption that previously allowed Mortgage Investment Corporations (MICs) to operate in BC without engaging in the onerous registration process with the BCSC. The impact of this announcement will be felt in the local industry as many small MICs will now have to endure registration costs.

ABOUT CMLS MORTGAGE ANALYTICS GROUP
The CMLS Mortgage Analytics Group (“MAG”) is a division of CMLS and the leading provider of independent mortgage valuation, risk ratings, market research and software to the commercial mortgage industry in Canada. Our clients include some of the largest institutional asset managers and insurance companies with assets under management ranging from single digit billions to over $100 billion.

Condoville: What is the real estate boom doing to downtown Montreal?

Units in high-rise condos are a hot commodity, but critics worry they will hurt the city’s vitality

On a cold Saturday morning in April, a small group of hockey fans mixed with real estate investors in the showroom of one of the many upscale condo developments in the city.

The 55-storey tower bills itself as “Montreal Canadiens-inspired,” and is being built in the shadow of the Bell Centre, near two other Habs-themed high-rises.

 

Guy Carbonneau, the team’s one-time captain and coach, was on-hand signing autographs, and hawking units.

“The Habs are built on a history of greatness and I believe Tour des Canadiens 3 will do the same for the Montreal real-estate landscape,” Carbonneau said, reading from a prepared statement.

Such is the velocity of Montreal’s condo market these days that everyone seems to be sucked into its orbit.

 

While the city’s real-estate market is enjoying a sustained growth period, downtown condo sales have been particularly hot.

Last year, 3,365 condo units were sold in central Montreal, a record that surpassed previous highs reached in 2012 and 2006, according to figures compiled by Altus Group, a real-estate data firm. There was a near 22-per cent increase in the fourth-quarter alone.

Former Candiens captain and coach Guy Carbonneau met with fans and investors at a recent event in the showroom of the Tour des Canadiens 3 condo development. (Jonathan Montpetit/CBC)


High-rise condo boom

Much of this growth was driven by new construction projects, such as the Tour des Canadiens 3, suggesting there is no longer any excess supply on the market.

“We’ve exhausted the inventory of unsold new units that were in the big towers during the difficult years of 2013, 2014 and 2015,” said Vincent Shirley, director of real-estate development at Altus.

“Today it is the launch of condo projects that is really effervescent. They will account for 50 per cent of first-quarter sales this year.”

Foreign investors have started to take note. They now account for roughly 1.7 per cent of Montreal purchases, though that’s small compared to Toronto (3.4 per cent) and Vancouver (4.8 per cent).

The high-rise condos in downtown Montreal are a bigger draw for professionals with no children or older people with equity looking to downsize. Market observers estimate as many as 25 per cent will be used as investments.

“What we’re seeing is people are wanting to live in larger spaces in the downtown. They want great views and to be able to walk to everything,” said Rizwan Dhanji, a residential sales executive with Canderel, the developer behind Tour des Canadiens.

High-rise projects with names like Crystal, YUL and the Drummond are the most ostentatious manifestations of the city’s hot condo market. (Jonathan Montpetit/CBC


In the condo development’s showroom, prospective buyers can visit a mock-up of a two-bedroom, 1000 square-foot unit.

Hints of the lifestyle on offer are embedded in the furnishings: modern leather-backed chairs, a crystal decanter on a quartz kitchen countertop, wooden Henriot box tucked away in the corner.

A floor-to-ceiling high-resolution photograph of the Saint-Lawrence River represents the view available to those who can afford the upper-level units.

Outside, Montreal’s new condo towers — imposing steel and glass structures rising 100 meters or more — are impossible to miss.

City of glass

With names like Crystal, YUL and the Drummond, they are the most ostentatious manifestations of the city’s hot condo market.

Many consider them to be its most problematic element as well.

Some of these concerns will be familiar to anyone who has followed recent developments in the country’s two other major real-estate market.

These include worries about affordability, which has declined steadily in Montreal since 2015. And some municipal politicians have mooted the need for a foreign-buyers tax.

But alongside the economic, there are architectural concerns. Not only have these residential skyscrapers reshaped the city’s skyline, they have dramatically altered the pedestrian experience along René Lévesque Boulevard and large parts of Griffintown.

In the condo development’s showroom, prospective buyers can visit a mock-up of a two-bedroom, 1,000 square-foot unit. (Jonathan Montpetit/CBC)


Like all skyscrapers, the new downtown condo towers block out sunlight and deflect air currents.

“You need lead shoes just to stay on the ground because of the wind vortex,” joked Dinu Bumbaru, policy director of the urban advocacy group Heritage Montreal.

And if the condo towers can be unpleasant to walk by, some feel they’re not much better to look at either.

“I don’t see virtue in any of them. It’s not architecture, it’s commodity,” said Phyllis Lambert, founder of the Canadian Centre for Architecture and an influential architecture critic.

“Montreal used to be a place where you would have high-rise buildings with light and air between them. But now it’s just a cavern down Réné-Lévesque.”  

Thinking beyond boom-and-boom

Neither Lambert nor Bumbaru are opposed to downtown condo-living per se. Indeed, both acknowledge the need for mid-rise residential building to combat sprawl.

But they are concerned that many of the high-rise condos are being built with little consideration for the impact they will have on surrounding neighbourhoods.

The Projet Montréal administration is expected to draw up a new master plan this year, which will guide zoning and development decisions.

They hope it will encourage a greater emphasis on the aesthetics of high-rise towers and the “strollability” of the surrounding area, by ensuring new developments don’t block out sunlight or include street-level stores, for instance.

Community groups, parents and the Commission Scolaire de Montréal (CSDM) have been pushing for a new French-language school in the downtown area, between Atwater and University streets. (Verity Stevenson/CBC)


Mayor Valérie Plante has also suggested making the downtown more accessible for families is a priority for her administration.

But many of the new condo developments don’t contribute to that goal, said Lambert.

She was dismayed to see that the development on the site of the old Montreal Children’s Hospital was allowed to proceed without setting aside space for an elementary school, which the neighborhood needs urgently.

“There isn’t proper planning in Montreal,” Lambert said.

Bumbaru, whose group intends to contribute several proposals for the new master plan, agreed. Proper planning, he said, should consider the city’s needs beyond the current boom in the real-estate market.

“In the past, we managed to generate genuine neighbourhoods with real life in them. But you wonder if the kind of building we’re doing today will support authentic city life because there is no room for families. The units are basically there to generate short-term gain for builders and investors,” he said.

“We have to raise our planning skills in this city.”


Jonathan Montpetit · CBC News · 

 

$70.8 million affordable housing investment for Ottawa

Middle-class families in Ottawa will benefit from 243 new rental units being built in the city with an investment from the federal government.

Two projects will be financed through the CMHC’s Rental Construction Financing initiative including $70.8 million for the construction of a twenty-seven storey building with 227 rental housing units. More than 200 will have rents lower than 30% of median household income in the area.

“The project represents a major step forward in sustainable design with ambitious design targets to reduce energy consumption by 50% and reduce carbon emissions by over 75% with an integrated geothermal system for the project,” said Neil Malhotra, Vice President, Claridge Homes who will build the 70 Gloucester development.

The other will be $3.9 million for a passive housing Centretown Citizens Ottawa Corporation project on Arlington Avenue. It will feature 16 rental housing units with rents well below 30% of median household income in the area.

“Through the National Housing Strategy, more middle class Canadians – and those working hard to join it – will find safe, accessible and affordable homes where their families can thrive and have the stability and opportunities they need to succeed. Our Government is committed to increasing the supply of rental units for Canadians through projects like the ones we are announcing today,” added Jean-Yves Duclos, the Minister responsible for Canada Mortgage and Housing Corporation.

 

by Steve Randall  Ι  24 Sep 2018

Bull run continues for BC commercial real estate

Investment activity in commercial real estate in British Columbia has continued its bull run in the first half of 2018.

A new report from Avison Young says there were 102 deals with a total value of $3.04 billion, the second highest on record for both deal count and total dollar volume.

However, a more cautious approach is being shown by investors in residential land amid rising political uncertainty, rising construction costs, and affordability issues.

Investors are questioning the high land values, especially in Vancouver. But for other CRE sectors, demand remains strong.

“Rising land values had the effect of increasing the cost of not only land, but any and all commercial real estate assets that included a land play,” comments Avison Young Principal Bal Atwal. “This has been one of the contributing factors of cap rate compression for a large majority of investment sale transactions over the last few years. As the land market now starts to take a slight breath, it remains to be seen over the next few months if the market will maintain its recent upward trajectory, stabilize at current levels or begin to falter.”

How the sectors are performing
Office investment sales activity in BC generated more than $1 billion in the first half of 2018 with 23 transactions valued at $1.04 billion.

The sale of BC retail assets remained exceptionally strong in the first half of 2018 with 43 transactions valued at $1.55 billion following the record-smashing retail investment sales performance of 2017.

Industrial investment activity still remained strong in the first six months of 2018 with 36 industrial transactions valued at $449 million – a slight decline from the first half of 2017 when 37 deals valued at $456 million were completed.

Sales activity of BC multi-family assets remained at historic heights with 42 transactions valued at $674 million in the first half of 2018 with the number of deals falling just short of the first half of 2017 (46) but with greater dollar volume ($652 million) than what was recorded a year ago.

 

by Steve Randall Ι  24 Sep 2018

Demand for high-quality apartment buildings in downtown Edmonton helps fuel record investment quarter

Investment in Edmonton’s multi-family residential rental and industrial market helped fuel a record-breaking quarter in 2018 as the province continues to claw its way out of recession.

According to data released by CBRE Limited, Edmonton had its best quarter ever in Q2 this year, recording $1.49 billion in commercial real estate investments, representing a 51 per cent increase from the previous quarterly record of $994 million set in the fourth quarter of 2016. This brings Edmonton’s first half investment total to $2.07 billion, which is an all-time high for a half-year period and up from the previous record of $1.7 billion set in the second half of 2016.

Dave Young, executive vice-president with CBRE Limited, said Friday the growth in investment in the multi-family market is being spurred on by consumers looking for high quality apartment buildings, especially in the downtown core.

“We’re starting to see a transition from old to new,” said Young. “If you look at the inventory of apartment buildings, a lot of that was built from the mid-1950s to maybe the early-1980s, so you have a lot of older stock out there and it’s not giving what tenants are demanding.”

Tenants are looking for newer amenities that older apartment buildings don’t have, such as en suite laundry, and developers are beginning to take advantage of that demand.

Ice District has helped to fuel the demand within the downtown core, said Young, but it’s also about a shift in mindset.

“It’s urbanization, it’s densification. In terms of transportation patterns, in terms of traffic and in terms of transit, everything is focused on an urban lifestyle and we’re finally getting to see that,” said Young, citing The Hendrix apartment building, 9733 111 St., as an example.

“Ice District, for sure, has had an impact on our downtown core for the positive, but you also look at 104 Street from basically 100 Avenue all the way to 104 Avenue, there’s downtown urban living there that wasn’t there when I got into this business in 1990.”

There is still some demand for development around the Anthony Henday, Young says, but it’s not as active as downtown.

Out with the old

The demand for higher quality buildings is also being felt in industrial markets.

Tenants are really demanding more functional space and are being more strategic where they invest, said Young. Vacancy rates remain healthy, but the majority of future vacancies will be in older industrial buildings that just aren’t as adaptive.

“It’s kind of like the old apartment buildings where you see tenants getting sucked out into the new ones, the same thing is happening in the industrial buildings,” said Young. “The days of a 19-foot, distribution building just off 142 Street and the Yellowhead, they’re gone.”

trobb@postmedia.com

@TrevorRobb_

Commercial Mortgages: “How to See the Deal”

When I first started working with Commercial Mortgages about 10 years ago, I had a hard time wrapping my head around what went into putting one of these deals together. Each deal is truly unique and I soon found can have many moving parts. In order to get a better understanding of what I was doing, I needed to put in place a process, or standardized approach that I could follow on all my deals. After a while, I found what works for me and wanted to share this approach. I found that there are several key factors that contribute to a typical deal and how addressing these factors can help you to “See the Deal”.

Since most, if not all commercial mortgages are paper-based and there really isn’t a web-based system like filogix that you can use to enter information into in order to produce a clear picture, the story or summary that is prepared for a commercial deal is very important. This summary gives me a good overview and allows me to “See the Deal” so that when I’m speaking to a prospective lender, colleague or drafting a quick email, I can highlight the critical points fairly quickly and concisely.

One way to “See the Deal” is to use the 3-legged stool or a 3-point triangle like the one at the beginning of this article. Basically, the main points or factors that I work with and focus on in my approach are:

1)     The Covenant

2)     The Income

3)     The Real Estate

The idea is to analyze each point and gather the necessary details for each in order to determine whether that point is weak or strong. What documentation do you need to assess each point? Also, what or where are the risks associated with each point and if necessary how can these risks be mitigated? How can you best sum up each point?

When looking at the ‘Covenant’, consider this;

  • What is the Borrower’s net worth? With commercial mortgage financing, the Borrower’s income is not that important since we don’t rely on their income to pay the mortgage – the property’s rent does. The Borrower’s net worth is more important.
  • Is the Borrower’s net worth all comprised of real estate or is it well diversified? How much in liquid assets do they have?
  • If they needed to inject funds into the property for emergency repairs (ie. Roof or HVAC  system needs a replacement immediately) or they need to cover the mortgage payment from their own resources due to unexpected or chronic vacancy, would they have the funds available?
  • How’s their personal credit? Are their taxes current? Do they have any other sources of income?
  • Etc

When looking at the ‘Income, we typically consider what determines and what can affect the property’s rent and this can include;

  • Cash flow. What does this look like? How much rent does the property generate? What is the likelihood that it will continue?
  • Net Operating Income (NOI), which is Income minus Expenses. The NOI is important since we use the NOI to calculate the two critical ratios used in commercial lending – the Loan To Value (LTV) and the Debt Coverage Ratio (DCR)
  • What are the leases like? Short term, long term? Do the tenants pay for any expenses such as taxes, utilities, insurance or maintenance? Ie. Are the leases Gross, Semi-Gross or Triple Net?
  • Do all the leases come due at the same time, in the same year or are they staggered over several years (this is known as Rollover Risk)?
  • Are the rents belowat or above market rents? How do they compare to similar properties? Are there yearly increases (step-ups)?
  • What type of tenants are they? Weak or strong? For example, Tim Horton’s is a great tenant; stand-alone restaurants, not so great. What’s the history of the tenancy?
  • What is the vacancy like and how has it been historically?
  • Does the client have a properly prepared Rent Roll?
  • Etc

Finally, when looking at the ‘Real Estate’ (which IS the lender’s main security) some of the points to consider are:

  • What type of property is it? Conventional, unconventional or special use? Can it be easily converted for other uses?
  • Where is it located? Is it urban or rural? Is it located in an area with other similar properties? Or does it stand out?
  • What is the property worth? How does the value compare to similar properties? Do we have an appraisal?
  • What is the property’s condition? Are there any major repairs or upgrades that are needed in the short or medium term?
  • How old is the property? Is the property too old to repair? Do we have a Building Condition Report (BCA)? Will we need one?
  • Are there any sources of environmental impact on or near the property? What is located acrossnext to or upgrade to the property? Do we have an Environmental Site Assessment (ESA)? Will we need one?
  • Etc

I’ve ended each section with Etc because by no means did I include all of the possible things to consider or questions to ask.

By being able to “See the Deal” a commercial broker will be able to discuss the file clearly. Discuss the strengths and weaknesses. Discuss the risk factors and what can be done to mitigate those factors. This will also help in gathering the necessary documentation and identify what will be required in order to proceed, quickly and efficiently.

The benefits to developing an approach similar to this are many. This allows for a more streamlined and standardized process which will also make a broker’s life easier when putting the deal together and making the process as painless as possible for the client.

It also instills confidence in the lenders you will be marketing the deal to since it shows some thought and insight into your underwriting. Also, one factor I know is critical with most lenders, is to have some conviction and to believe in the deal; when submitting a file for review I find that really standing behind the deal, “…I recommend the deal based on…..” and list your thoughts goes along way versus saying, “….I have a deal….what do you think……?”. “Seeing the Deal”, makes it easier to stand behind the deal and express why. This will only strengthen your relationship with your lenders.

In the end, this will result in a quicker turn around and the ability to get a better deal for your client.

 

Ermanno Tasciotti  | January 2018

Toronto’s Tale of Two Markets Is Hot Condos and Cold Houses

  • New regulations, rising interest rates will mute spring sales
  • Immigration, high-tech jobs to keep floor under market

It’s a tale of two housing markets in the Toronto area as Canada’s biggest city gears up for the crucial spring selling season: sales of big detached homes are slow, while condo deals are booming.

On one side are people like Karen Berends, who put her C$1.5 million ($1.2 million) house back on the market in nearby Oakville this month after two failed attempts to sell in the past year. She reduced her asking price by about C$51,000, but still there are no takers, and she’s kicking herself for not cashing out last spring when the market was in a frenzy.

“We could’ve walked away with a really good amount of money in our bank account if we had taken the money last year, but our head wasn’t in it at that point,” Berends said in a phone interview. “It’s been a complete 360 this time around — it’s absolutely dead.”

Then there’s Beth O’Donoghue, a sales representative at Brad J. Lamb Realty Inc., who says the market is as hot as it’s ever been. Her clients recently lost out in three separate condo bidding wars in a week, including one with 11 offers. That’s convinced O’Donoghue, who’s invested in four new condos herself in the city in the past four years, to hold onto her assets for now.

One she bought in pre-construction for C$420,000 and figures she could sell for close to C$700,000. “If you would have told me three years ago when I bought this place that I would’ve made this much money on it already, I would have said you’re crazy,” she said.

Polar Opposites

After a decade as one of the world’s hottest housing markets, Toronto is moving in two directions. Transactions have certainly cooled since May as the government introduced new rules to tame runaway prices. But the impact has been largely on big, expensive detached homes, with sales plunging 41 percent in February from a year earlier, and prices dropping 12 percent since hitting a record last year. Condo prices, in contrast, soared about 20 percent since last February.

Toronto Market Heat Moves to Condos

The deviation is largely as a result of mortgage regulations that went into effect on Jan. 1 as well as rising interest rates. The rule requires that even people with a 20 percent down payment, who don’t require mortgage insurance, prove they can make payments at least 2 percentage points above the rates under which they go into contract.

That’s pushing buyers out of the detached segment and right into the condo market.

“I’ve been looking at the condo market for years and I’ve been waiting for it to correct and it’s just not happening,” Patrick Rocca, a real estate agent at Bosley Real Estate Ltd., said by phone. “Honestly, this scares me. When you have condos selling at C$1,000 to C$1,200 per square foot for resale, that’s mind-boggling.”

Slower Spring

Real estate agents and economists expect some stabilization in the detached market as the spring selling season swings into full gear, but the price spikes of last year are probably history. The condo market is likely to keep chugging, bolstered by millennials in high-paying technology and financial jobs, strong immigration and pinched supply, according to Bank of Montreal economists.

“Spring will probably take a little more time to get going than years past, but there’s so much demand in the marketplace as Toronto continues to attract people around the country and the globe,” said Christopher Alexander, regional director at real estate firm Re/Max Integra.

Meanwhile, things are getting tough for tenants too. The combination of stress tests, urbanization and high home prices is creating the perfect formula for skyrocketing rents, said Simeon Papailias, co-founder of the Real Estate Center, a Toronto-based real estate management company. Many homebuyers who no longer qualify for a mortgage are turning to renting instead, which in turn attracts investors who want to become landlords.

“This market is creating new monsters — it’s taking a life of its own and it’s creating a new marketplace,” Papailias said by phone.

Chinese Buyers

Berends, the Oakville homeowner, has placed ads in several Chinese media outlets in hopes of attracting foreign shoppers. “Apparently there are still buyers in mainland China, but they’re not really jumping,” she said.

She’s hoping to retire to a home she’s building north of the city in a few years, but she’s waiting for the right price for her existing house.

“I’m thinking we might have to take it off and wait till next year,” she said. “It’s just so difficult to know.”

By: Nathalie Wong

— With assistance by Erik Hertzberg

29 March 2018

Commercial Real Estate Loan (CRE)

Commercial Real Estate Loan (CRE) is income-producing real estate that is used solely for business purposes, such as retail centers, office complexes, hotels, and apartments. Financing – including the acquisition, development, and construction of these properties – is typically accomplished through commercial real estate loans: mortgage loans secured by liens on commercial, rather than residential, property.

Just as with residential loans, banks and independent lenders are actively involved in making loans on the commercial real estate. Also, insurance companies, pension funds, private investors and other capital sources, make loans for the commercial real estate.

Let’s take a look at commercial real estate loans: how they differ from residential loans, their characteristics and what lenders look for.

Individuals vs. Entities

While residential mortgages are typically made to individual borrowers, commercial real estate loans are often made to business entities (e.g., corporations, developers, partnerships, funds, and trusts). These entities are often formed for the specific purpose of owning commercial real estate.

An entity may not have a financial track record or any credit history, in which case the lender may require the principals or owners of the entity to guarantee the loan. This provides the lender with an individual (or group of individuals) with a credit history and/or financial track record – and from whom they can recover in the event of loan default. If this type of guaranty is not required by the lender, and the property is the only means of recovery in the event of loan default, the loan is called a non-recourse loan, meaning that the lender has no recourse against anyone or anything other than the property.

Loan Repayment Schedules

A residential mortgage is a type of amortized loan in which the debt is repaid in regular installments over a period of time. The most popular residential mortgage product is the 30-year fixed-rate mortgage.

Residential buyers have other options, as well, including 25-year and 15-year mortgages. Longer amortization periods typically involve smaller monthly payments and higher total interest costs over the life of the loan, while shorter amortization periods generally entail larger monthly payments and lower total interest costs. Residential loans are amortized over the life of the loan so that the loan is fully repaid at the end of the loan term. A borrower with a $200,000 30-year fixed-rate mortgage at 5%, for example, would make 360 monthly payments of $1,073.64, after which the loan would be fully repaid.

Unlike residential loans, the terms of commercial loans typically range from five years (or less) to 20 years, and the amortization period is often longer than the term of the loan. A lender, for example, might make a commercial loan for a term of seven years with an amortization period of 30 years. In this situation, the investor would make payments for seven years of an amount based on the loan being paid off over 30 years, followed by one final “balloon” payment of the entire remaining balance on the loan. For example, an investor with a $1 million commercial loan at 7% would make monthly payments of $6,653.02 for seven years, followed by a final balloon payment of $918,127.64 that would pay off the loan in full.

The length of the loan term and the amortization period will affect the rate the lender charges. Depending on the investor’s credit strength, these terms may be negotiable. In general, the longer the loan repayment schedule, the higher the interest rate.

Loan-to-Value Ratios

Another way that commercial and residential loans differ is in the loan-to-value ratio (LTV): a figure that measures the value of a loan against the value of the property. A lender calculates LTV by dividing the amount of the loan by the lesser of the property’s appraised value or purchase price. For example, the LTV for a $90,000 loan on a $100,000 property would be 90% ($90,000 ÷ $100,000 = 0.9, or 90%).

For both commercial and residential loans, borrowers with lower LTVs will qualify for more favorable financing rates than those with higher LTVs. The reason: They have more equity (or stake) in the property, which equals less risk in the eyes of the lender.

Commercial loan LTVs, in contrast, generally fall into the 65% to 80% range. While some loans may be made at higher LTVs, they are less common. The specific LTV often depends on the loan category. For example, a maximum LTV of 65% may be allowed for raw land, while an LTV of up to 80% might be acceptable for a multifamily construction. There are also private mortgages available for commercial lending.

Debt-Service Coverage Ratio

Commercial lenders also look at the debt-service coverage ratio (DSCR), which compares a property’s annual net operating income (NOI) to its annual mortgage debt service (including principal and interest), measuring the property’s ability to service its debt. It is calculated by dividing the NOI by the annual debt service. For example, a property with $140,000 in NOI and $100,000 in annual mortgage debt service would have a DSCR of 1.40 ($140,000 ÷ $100,000 = 1.4). The ratio helps lenders determine the maximum loan size based on the cash flow generated by the property.

A DSCR of less than 1 indicates a negative cash flow. For example, a DSCR of .92 means that there is only enough NOI to cover 92% of annual debt service. In general, commercial lenders look for DSCRs of at least 1.25 to ensure adequate cash flow. A lower DSCR may be acceptable for loans with shorter amortization periods and/or properties with stable cash flows. Higher ratios may be required for properties with volatile cash flows – for example, hotels, which lack the long-term (and therefore, more predictable) tenant leases commonly to other types of the commercial real estate.

Interest Rates and Fees

Interest rates on commercial loans are generally higher than on residential loans. Also, commercial real estate loans usually involve fees that add to the overall cost of the loan, including appraisal, environmental report, legal, loan application, loan origination and/or survey fees. Some costs must be paid up front before the loan is approved (or rejected), while others apply annually. For example, a loan may have a one-time loan origination fee of 1%, due at the time of closing, and an annual fee of one-quarter of one percent (0.25%) until the loan is fully paid. A $1 million loan, for example, might require a 1% loan origination fee equal to $10,000 to be paid up front, with a 0.25% fee of $2,500 paid annually (in addition to interest).

Prepayment

A commercial real estate loan may have restrictions on prepayment, designed to preserve the lender’s anticipated yield on a loan. If the investors settle a debt before the loan’s maturity date, they will likely have to pay prepayment penalties. There are four primary types of “exit” penalties for paying off a loan early:

  • Prepayment Penalty. This is the most basic prepayment penalty, calculated by multiplying the current outstanding balance by a specified prepayment penalty.
  • Interest Guarantee. The lender is entitled to a specified amount of interest, even if the loan is paid off early. For example, a loan may have a 10% interest rate guaranteed for 60 months, with a 5% exit fee after that.
  • Lockout. The borrower cannot pay off the loan before a specified period, such as a 5-year lockout.
  • Defeasance. A substitution of collateral. Instead of paying cash to the lender, the borrower exchanges new collateral (usually Treasury securities) for the original loan collateral. High penalties can be attached to this method of paying off a loan.

Prepayment terms are identified in the loan documents and can be negotiated along with other loan terms in commercial real estate loans. Options should be understood ahead of time and evaluated before paying off a loan early.

The Bottom Line

With commercial real estate, it is usually an investor (often a business entity) that purchases the property, leases out space and collects rent from the businesses that operate within the property: The investment is intended to be an income-producing property.

When evaluating commercial real estate loans, lenders consider the loan’s collateral; the creditworthiness of the entity (or principals/owners), including three to five years of financial statements and income tax returns; and financial ratios, such as the loan-to-value ratio and the debt-service coverage ratio.

By: Daniela Peeva |  June 26, 2017

Commercial Properties Skyrocket in Numbers 2015

According to Real Capital Analytics, $533 billion of commercial real estate changed hands last year, up 23% from a year earlier. The volume also was roughly 4% more than what had been projected as of November 2014.

The total was still well shy of the record $574.9 billion of deal volume that took place during the market’s peak year of 2007.

Foreign investors accounted for $91.1 billion, or 17.1% of the transaction volume last year, up from the 10% average in each of the previous four years. The foreign charge was led by the Canadians, who completed $24.6 billion of deals. Those investors include the Canada Pension Plan Investment Board and Caisse de depot et placement du Quebec (CDPQ). Ivanhoe Cambridge, an affiliate of CDPQ, purchased Manhattan’s Stuyvesant Town/Peter Cooper Village apartment property for $5.3 billion late last year.

Investors from Singapore took the second largest piece of the foreign investment pie, completing $14.8 billion of deals in 2015. Norway followed with $8.5 billion of deals, and Chinese investors completed $6.8 billion of deals.

Under normal circumstances, foreign investors would likely increase their activity going into 2016. After all, certain restrictions have been eased as a result of changes to the Foreign Investment in Real Property Tax Act. (These changes were implemented with the passage of the Protecting Americans from Tax Hikes Act of 2015.) For instance, foreign pension funds are no longer are subject to withholdings under the original act.

However, many foreign investors are likely getting pinched by the sharp drop in oil prices. According to analysis by Morgan Stanley, Norway, the United Arab Emirates and Qatar combined for $18.6 billion of U.S. deals, a substantial volume. Since each country is reliant almost exclusively on oil revenue, their ability to generate cash will decline with the drop in oil prices.

In fact, as oil prices were plunging last year, sovereign wealth funds were redeeming capital from investment vehicles (not necessarily tied to real estate) to which they had committed. Morgan Stanley found that some $100 billion of capital was redeemed from 11 asset managers by oil-dependent investors last year. That trend could continue this year if oil prices continue to decline, or stabilize at today’s lower prices.

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