Defeasance is a strategy that permits repayment of a commercial property loan on a property, to facilitate sale or refinance.
Debt yield, is a measure of risk for commercial mortgage lenders. It takes into account the net operating income of a commercial property to determine how quickly the lender could recoup their funds in the event of default.
Debt service coverage ratio or DSCR, is a comparison between net operating income and debt service on an annual basis and is generally one of the most important considerations when a commercial mortgage broker, lender or bank is underwriting a loan.
An interest-only loan is a type of loan in which the borrower only needs to pay the interest, not the principal, for a specific amount of time. This period will typically be laid out in the loan agreement. After the interest-only period of the loan ends, the loan will become a typical, amortizing loan, in which the borrower contributes to both the interest and the principal of the loan with each payment.
Securitization is the process in which commercial or residential real estate loans are pooled together, packaged into a financial product, and sold to investors on the secondary market. Not all types of commercial real estate loans are securitized, but many are. For instance, CMBS and conduit loans are always securitized and sold as commercial mortgage backed securities. In contrast, many, but not all HUD multifamily loans and Fannie Mae/Freddie Mac multifamily loans are securitized.
Debt Coverage Ratio (DCR), is a measurement of a property’s net operating income divided by its debt service. A property’s Debt Coverage Ratio, which is also known as its Debt Service Coverage Ratio (DSCR), is one of the most important eligibility factors for commercial real estate loans. Keep in mind that net operating income can be calculated by subtracting a property’s gross revenue by its operating expenses. DCR/DSCR can also be applied to an entire company, as well as a single property, which is more relevant in the case of owner-occupied commercial properties.
How Does Earnest Money Work in Commercial Real Estate?
Earnest money is a deposit made to the seller of a commercial property in order to demonstrate the buyer’s intention to purchase the property. Putting down earnest money gives a buyer additional time to finish the approval process for their loan, order a property appraisal, and have property inspections and other third-party reports completed before purchasing the property.
How Much Earnest Money is Needed?
Earnest money is not always needed in a commercial real estate property transaction, but in general, it’s typically around 1% of the purchase price. However, it’s completely up to the seller as to how much earnest money they want a borrower to put down. For desirable properties in hot markets, sellers may ask for 5%, 10%, or even a 15% earnest money deposit to reserve a property.
Is Earnest Money Refundable?
Whether earnest money is refundable depends on the specific contract that a buyer has with the seller. In many cases, a potential buyer’s earnest money is not refundable, even if they cannot get financing to purchase the property in question. However, in other cases, it may be fully refundable if the buyer cannot get financing. Earnest money is almost always refundable, however, if the seller decides to pull out of the deal.
What Happens to Earnest Money?
If a commercial real estate deal successfully goes through, in the vast majority of cases, the earnest money will be credited toward the purchase price of the property. As mentioned previously, however, if they buyer pulls out of the deal, the money will often stay with the seller, whereas if the seller pulls out, the money will usually be refunded to the buyer.
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Commercial equity lines of credit, also known as CELOCs, involve a commercial real estate owner being given a line of credit that allows them to borrower against the equity in their property. Commercial equity lines of credit can be used for a variety of purposes, including growing your business by hiring new employees, obtaining new inventory, financing property improvements, or even purchasing a new piece of real estate. CELOCs are much like the home equity lines of credit (HELOCs) found in residential real estate.
A sublease, or sublet, occurs when a tenant assigns part or all of their lease to a new tenant. In general, most commercial leases permit subletting, but not all do. Many commercial landlords will charge a fee for subletting in order to compensate for the additional risks and hassles that may occur due to dealing with an additional tenant.
In commercial real estate finance, seasoning refers to the amount of time that a borrower has held a specific loan. Therefore, a seasoned loan is a one that has been held for a certain period of time. Many types of loans, including HUD multifamily loans and Fannie Mae/Freddie Mac multifamily loans have specific loan seasoning rules, especially when it comes to refinancing. In addition, most commercial and multifamily lenders will not let you take out a commercial equity line of credit unless your loan has been seasoned for at least one year.
If you want to purchase a commercial property, you’ll almost always need to get an appraisal first. An appraisal is a professional estimation of the market value of a property, which needs to be conducted by a certified appraiser in the area which the property is located. In most cases, commercial real estate lenders require an appraisal before they approve a borrower for a loan, since they need to determine the value of a property in order to accurately calculate its loan-to-value ratio and other important financial metrics.
When it comes to making a decision on whether to invest in a commercial property, there are a variety of variables that an investor can take into account. First and foremost, in many cases, is return on investment, which calculates the amount of money that a investor will make compared to the amount of money they’ve invested into the property, minus any expenses. Other variables include the safety of an investment property, a property’s development potential, the property’s location, and an individual investor’s financial instincts.
In commercial real estate, return on investment (also known as ROI), is a measurement of how much money an investor receives after all expenses have been deducted. The formula for ROI is:
ROI = (Investment Gain - Investment Cost)/Cost of Investment
Many factors can affect the ROI of a commercial real estate investment, including the size of any commercial real estate loans on the property, the interest rate of those loans, as well as any management, repair, or renovation expenses needed to maintain or upgrade the property.
When an investor or developer sells a commercial property, they'll usually have to pay taxes then and there-- but not always. An IRS 1031 exchange is a transaction that allows a commercial property seller to defer paying taxes on the sale of the property if they use the funds to buy another, similar property within a specific period of time.
In commercial real estate, the floor plate is the amount of leasable square footage on an individual floor of a building. In multistory buildings, especially taller office properties in major urban areas, the floor plate on lower floors is likely to be larger than the the floor plate on higher floors. In some cases, a building's floor plate is also known as its footprint.
A waterfall and promote structure, also known as a waterfall model, is a method for distributing the profits from a real estate investment in an uneven way. Typically, the project's sponsor (the individual or group putting most of the work in to identify, acquire, and manage the property) will receive a disproportionate share of the profits, known as a promote, as long as the project hits certain profitability benchmarks.
In hotel construction and acquisition, price per key is a metric that compares the amount of money spent on building or aquiring the hotel with the amount of rooms, or keys, in the hotel. To determine price per key, simply use the formula below:
Total Hotel Construction or Acquisition Cost/Total Number of Rooms (Keys) = Price Per Key
The break-even ratio for a property is the percentage of its gross operating income that the property needs to break even, i.e. for costs to equal expenses. Investors can use a property's break-even ratio to determine if it's a good investment; too high of a break-even ratio may be a red flag. Break-even ratio can be calculated using the formula below:
Debt Service + Operating Expenses/Gross Operating Income = Break-even Ratio
RevPar, or revenue per available room, is a measure of a hotel's financial performance, which can be calculated by dividing a hotel's total room revenue by the amount of available rooms. Another easy way to calculate RevPar is to multiply a hotel property's ADR (average daily rate) by its occupancy rate.
An anchor tenant is the largest or most prominent store in a retail commercial real estate development, intended to help draw customers into the area. In strip centers and power centers, anchor tenants are often big-box stores or grocery stores, while in shopping malls, they're more likely to be department stores.