1. 1 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin CHAPTER 17 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 10- years, and often include a ballon payment. Commercial mortgages are often nonrecourse loans.

2. 2 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin COMMON TYPES OF PERMANENT MORTGAGES Balloon Mortgages Common Loan Provisions –lock-out, prepayment, and yield maintenance provisions Floating Rate Loans Installment Sale Financing

3. 3 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Example Commercial Mortgage Loan Terms

4. 4 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin PERMANENT MORTGAGES WITH EQUITY PARTICIPATION Participation Mortgages –income kickers –equity kickers –contingent interest

5. 5 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin OTHER EQUITY PARTICIPATION ARRANGEMENTS Joint Ventures Sale-Leasebacks

6. 6 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 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

7. 7 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin 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.

8. 8 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The Effect of Leverage

9. 9 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin THE LOAN SUBMISSION PACKAGE Loan Application Property Description and Legal Aspects Cash Flow Estimates Appraisal Report and Feasibility Study

10. 10 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin LOAN UNDERWRITING The Property and Borrower –Property Type, Quality, and Location –Tenant Quality and Lease Terms –Environmental Concerns –Borrower Experience and Resources

11. 11 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin The Maximum Loan Amount The Loan-to-Value Ratio: LTV = V m / V o The Debt Service Coverage Ratio: DCR = NOI / Debt Service The Break-Even Ratio: BER = (OE + DS) / EGI

12. 12 Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin ACQUISITION, DEVELOPMENT, & CONSTRUCTION LOANS Land Purchase and Development Financing Construction Financing –take-out commitments –gap loans –open-ended loans –mini-perm. loans