Prepayment Penalties in Commercial Real Estate

What is an Prepayment Penalty in Commercial Real Estate? 

In commercial real estate loans, a prepayment penalty is a fee charged to borrower if they attempt to repay their loan early. When a lender issues a loan, they typically want to lock in their profit for a certain amount of time, so the prepayment penalty is a way to compensate them for their financial loss if the loan is paid off early. 

Lock outs in Commercial Real Estate 

While most types of commercial real estate loans have prepayment penalties, many also have lock out periods-- a specific period of time in which a borrower cannot repay the loan, no matter what. Therefore, borrowers should be very careful when looking at commercial real estate loans with long lock out periods, as these may make it very difficult to sell the property before the lock out period is over. 

Step Downs vs. Soft Step Downs 

After the lock out period (if there is one), a borrower can often pay off their loan for a certain percentage of the loan amount. If the percentage declines year by year, for example, 6% in the first year, 5% in the second year, 4% in the third year, and so on, it's called a step down prepayment penalty. In comparison, some loans have what's called a soft step down prepayment penalty. Soft step down penalties usually start lower and decline more slowly. For example, instead of the 6-5-4-3-2-1 step down in the example above, a loan might have a 4-3-3-2-2-1 soft step down penalty. 

USing Defeasance to Pay off A Loan Early 

Some commercial real estate loan types, such as CMBS loans and certain kinds of life company loans may be much more difficult to get out, since there is external pressure on the lender to provide a certain rate of return. For CMBS loans, the CMBS bondholders expect a certain, guaranteed return, and life insurance companies need to know they can pay policy beneficiaries the promised amounts on their life insurance policies. If a borrower wants to get out of one of these loans, they will usually have to engage in a process called defeasance, in which they will  purchase government-backed securities, such as treasury bonds, in order to repay the loan and guarantee the lender a specific rate of return. 

Assumable Loans And Prepayment Penalties 

As previously mentioned, prepayment penalties on commercial real estate loans can be a big hassle if the borrower wishes to sell the property with a few years after purchasing it. That's why borrowers may wish to check if a loan is assumable before making a final decision. An assumable loan can be transferred to a new buyer (with the lender's approval) typically for a small fee. A commercial property with an assumable loan may actually be easier to market, since the new owner may not have to go through as many hoops as they would to take out an entirely new commercial real estate loan. 


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Assumable Loans in Commercial Real Estate

Assumable Loans in Commercial Real Estate

In commercial real estate, an assumable loan is a loan that can be taken over by a buyer when the owner of the property sells. Determining whether or not a loan is assumable (and under what conditions it can be assumed by a new buyer) can be very important, since otherwise, an owner/investor could face significant prepayment penalties if they need to pay off the loan in order to sell the property. 

Discounted Cash Flow Analysis in Commercial Real Estate

Discounted Cash Flow Analysis in Commercial Real Estate

Discounted Cash Flow Analysis, or DCF analysis, is a method used to determine the current value of a set of cash flows using a predetermined discount rate. In practice, DCF analysis is often used to compare the potential return from a commercial real estate investment to the estimated return from another investment, such as a stock, mutual fund, private equity investment, or another piece of commercial real estate. 

Equity Multiple in Commercial Real Estate

Equity Multiple in Commercial Real Estate

The equity multiple is one of the most important and effective financial metrics used in commercial real estate. An equity multiple is designed to compare the cash that an investor has put into an investment to the amount of cash that the investment has generated over a specific period of time. 

Load Factor in Commercial Real Estate

Load Factor in Commercial Real Estate

A load factor, also known as a loss factor, is a metric that compares the amount of space a tenant has to pay for in a commercial lease, versus the amount of space they can actually use. The load factor or a commercial lease can be calculated with the formula below: 

Rentable Square Feet/Usable Square Feet = Load Factor 

Load factor is important because tenants in commercial leases, especially leases for office buildings or large retail developments like malls, typically have to pay for their percentage of a building's common areas.

The 1% and 2% Rules in Commercial Real Estate

The 1% and 2% Rules in Commercial Real Estate

If you're a commercial real estate investor deciding whether a property is a good fit for your portfolio, you might have heard of the 1% or the 2% rule. The 1% rule states that a property's monthly rent must be at least 1% of its purchase price in order for the owner to break even. The 2% rule states that a property's monthly rent needs to be at least 2% of its purchase price in order for the owner to make a sustainable profit. 

Multifamily Property Classes in Commercial Real Estate

Multifamily Property Classes in Commercial Real Estate

Much like office properties are classified by quality as either "A", "B", or "C" properties, multifamily properties such as apartments can also be classified this way. However, unlike office buildings, multifamily properties are often classified from "A" through "D."

Occupancy Rate in Commercial Real Estate

Occupancy Rate in Commercial Real Estate

Occupancy rate is one of the most important metric for temporary housing, which includes multifamily properties like apartment buildings, as well as hospitality properties, like hotels, motels, and resorts. Occupancy rate can be measured by dividing the number of occupied nights by the number of available nights.

ARV: After Repair Value in Commercial Real Estate

ARV: After Repair Value in Commercial Real Estate

If you're an investor or developer interested in purchasing and rehabilitating distressed commercial property, after repair value, or ARV, is one metric you should know. The after repair value of a property is simply the property's market value after any repairs, renovations, or improvements have taken place.

CTL: Credit Tenant Leases in Commercial Real Estate

CTL: Credit Tenant Leases in Commercial Real Estate

A credit tenant lease (CTL) is a form of commercial real estate financing in which a loan is given for a property with a long-term lease (usually 10+ years), typically held by a nationally recognized tenant with a high credit rating. Due to the additional security of having a high-credit tenant, lenders are often significantly more flexible when it comes to loan terms for CTLs.

FAR: Floor Area Ratio in Commercial Real Estate

FAR: Floor Area Ratio in Commercial Real Estate

Floor area ratio, or FAR, is the ratio between a building's floor area and the size of the land on which the property is located. The larger a property's FAR ratio, the higher density the project has. FAR is often limited by zoning laws, so it's important for investors and developers looking to build a new project to check out local FAR limits early on in the planning process.

Expense Stops in Commercial Real Estate

Expense Stops in Commercial Real Estate

In a full service gross lease, the tenant pays a base rental rate, and landlord is typically responsible for paying any additional expenses (such as CAM fees), except for those that go above a specific amount, called an expense stop. Any expenses that exceed the expense stop then become the responsibility of the tenant.

Breakeven Occupancy in Commercial Real Estate

Breakeven Occupancy in Commercial Real Estate

Breakeven occupancy is the occupancy at which a commercial real estate property goes from having an operating deficit to an operating surplus. It can also be defined as the point at which effective gross income (EGI), equals operating expenditures (OpEx) and debt service. If a property is exactly at breakeven occupancy, it's DSCR will be exactly 1.00. 

ADR: Average Daily Rate in Commercial Real Estate

ADR: Average Daily Rate in Commercial Real Estate

Average Daily Rate, or ADR, is one of the most important metrics that hotels use in order to determine the income and profitability of a property. ADR can be determined by dividing the entire rental income for a day by the number of occupied rooms on a property. For example, if a hotel made $50,000 in one day, as a result of 100 rooms being rented, their ADR for that day would be $500. 

Parking Ratio in Commercial Real Estate

Parking Ratio in Commercial Real Estate

A parking ratio is a statistic that takes the number of available parking spaces in an office property and divides it by the property's entire gross leasable area (GLA). This ratio is most commonly expressed per every 1,000 sq. ft. of property, i.e. a 20,000 sq. ft. office building with 100 parking spaces would have a parking ratio of 5 (spaces per 1,000 sq. ft.).

GRM: Gross Rent Multiplier in Commercial Real Estate

GRM: Gross Rent Multiplier in Commercial Real Estate

When it comes to determining whether a commercial or multifamily real estate project is a good investment, there are a variety of methods you can use-- and one of the most effective is to use a project's gross rent multiplier, or GRM, in order to help calculate the value of the property. A gross rent multiplier is defined as the number of years a property would take to pay for itself in gross rent--i.e. not taking into account insurance, property taxes, utilities, and other expenses.) 

LURA: Land Use Restrictive Agreements in Commercial Real Estate

LURA: Land Use Restrictive Agreements in Commercial Real Estate

In certain multifamily real estate projects, an owner/developer will give up some of their rights via a Land Use Restrictive Agreement, or LURA, in order to receive tax credits in the future. The LURA will specifically document the restrictions placed upon the property, and typically help guarantee that the project will receive a specific number of LIHTC credits over a specific time period. 

LIHTC: Low Income Housing Tax Credits in Commercial Real Estate

LIHTC: Low Income Housing Tax Credits in Commercial Real Estate

Low Income Housing Tax Credits, or LIHTC credits, are federal tax credits designed to encourage private businesses to invest in affordable housing. In the last three decades, LIHTC has assisted in the financing of nearly 2.5 million affordable rental units across the U.S. While LIHTCs apply to multifamily apartment developments and not purely commercial real estate developments like office buildings or retail projects, many developers of mixed-use projects do use LIHTC credits. 

Sale Leaseback in Commercial Real Estate

Sale Leaseback in Commercial Real Estate

In commercial real estate, a sale leaseback is a transaction in which one party sells a piece of real estate, and then leases that real estate back from the new owner, usually under a pre-arranged contract. Sale leasebacks can be especially helpful for business owners who are holding onto expensive retail or office property, but have cash flow problems or need equity to expand their business. 

Class A, B, and C Buildings in Commercial Real Estate

Class A, B, and C Buildings in Commercial Real Estate

In commercial real estate, office buildings are typically placed in one of three categories; class A, class B, or class C. Each category delineates a different level of price, quality, and amenities. However, since real estate quality varies greatly from place to place, A, B, and C classifications are subjective, and can only be based on what's available in a specific, local area.