Commercial Real Estate Q&A: Your Top Questions Answered

Commercial Real Estate Questions
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We’re starting something new here at The Commercial Investor.

Our goal is to share with you the knowledge and experiences that have gotten us to the successful heights we find ourselves at — and there’s nothing loftier than being a source of education for others.

….Assuming you have something valuable to teach.

And that we do.

See, we didn’t get where we are by figuring the hard parts out and falling on our faces once or twice. With that experience, comes knowledge.

So, today we start a new series. One in which we answer the most frequently asked (and valuable) questions in the industry.

Bookmark this page and check back regularly because we’ll be covering all the good stuff.

For our first installment, we’ll be answering the top 3 questions asked regarding Commercial Mortgages.

Let’s dive right in.

Commercial Mortgage Q&A: Top 3 Questions

1. Can I assume a loan on a property which I am acquiring?

It depends, but generally, yes.

Let me explain…

When a lender originates the loan, they have the choice of allowing the borrower to have one (or more) transfers during the term of the loan, subject to the lender’s approval. Lenders typically allow this because it gives the borrower some flexibility, but also because there is a higher likelihood that this loan will perform for the intended term.

For example, if I originate a 10-year loan for Michael to buy 123 Main Street, I will allow a one-time transfer provision.

Now let’s say that in year 6 of the loan, Michael chooses to sell the property to Cynthia because he wants to take out some equity for another project.

Cynthia is able to assume the loan on the property with my approval as a lender.

And being the lender, I’m OK with this, because when I made that 10 year loan, I’d like for it to be out there for as close to 10 years as possible. Plus, I think Cynthia is a well-capitalized buyer with a good reputation…

One attractive scenario where this can be useful for a seller…

Let’s say I buy a property and get a 10-year fixed rate mortgage with a fixed interest rate of 3.5% and the borrower is allowing transfer rights.

In year 3 of owning the property, I choose to sell.

Now we all know interest rates can move up and down, so let’s assume that 10-year fixed rate mortgages now have interest rates of 7% (much higher than the 3.5% rate I currently have on my property).

With this loan being assumable by a qualified buyer, I can get a premium on my sales price because the mortgage comes with it.

So instead of a buyer paying a 7% rate on a new mortgage, he can assume mine at 3.5% and increase his return on the investment without doing anything.

Buyers are willing to pay a premium for this property because their cash flows are going to be more attractive for the remainder of the loan term than if they received debt at current market rates.

(NOTE: Want access to The Commercial Investor business vault? Right now we’re offering access to systems, strategies, templates, trainings, and recordings. It’s all included in The Investors Syndicate, and is available to you here.)

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2. Should I get an interest only or amortizing loan?

I love this question.

And again, it depends.

It’s mostly dependent on your investment horizon, but other things come into play.

First, let’s identify the difference between the two. Interest only loans mean, well, just what it sounds like. Your debt service only consists of interest payments, so there is no portion of your payment going towards the principal.

That means that the loan’s principal balance will not change throughout the loan term. On an amortizing loan, each debt service payment has a portion going towards interest and a portion going towards the principal.

Here, the principal balance of the loan is declining each month by the portion of the principal paid.

The big differences:

  1. Interest-only loan payments are less than amortizing loan payments.
  2. The principal balance of amortizing loans decreases over time; interest-only loans have the same balance throughout the loan term.

A lot of investment managers or funds prefer to get interest-only loans for their deals. The general thought process is that it’s a boost in their cashflows early on which increase their projected returns on the entire project.

For interest-only loans, the debt service payment is less than that of amortizing loans, which means the sponsor is receiving more income from the property every month. Having those chunkier cash flows upfront help the returns.

Plus, they can invest those dollars into capital improvements, which will accelerate the property’s appreciation, and still have a decent spread between the collateral value and loan balance.

Now, there are some other investors, some family offices and high net worth guys, that plan to hold certain real estate for the long term, like 20-30 years.

And generally, these guys are not particularly interested in returns but more so the preservation of wealth.

And if they choose to put debt on a property, their preference is to let it amortize down to nothing so they can have a free and clear asset in their trust for the next generation.

3. What can I negotiate with a lender on my term sheet and loan docs?

Everything!

Typically, you only hear about the interest rate being negotiated from people.

And honestly, that’s the toughest thing to negotiate. Lenders generally have a set of guidelines for yield requirements and there is often little flexibility there.

Yes, sometimes it can move here and there and, if you’re a repeat borrower or a big player, you have more power to get that movement.

However, there are so many other things to be negotiated:

  • Interest only period (number of years)
  • Prepayment Fees: Lenders usually come out with something strong; borrowers can chip away but lenders always get something here.
  • Upfront Fees: Lenders may have different groupings for legal, administration, loan fees, etc. or they group them all together. Question everything and always fight to get a better deal. Every penny counts!
  • Transfer Provisions: We talked about this already but it’s great to have this in there. Having the right to transfer the debt to a qualified buyer can increase your odds of a successful exit strategy.
  • Transfer Fees: Once you get the transfer right approved, lenders will ask for a fee, anywhere from 50 basis points to 2%. Standard from my experience is 1%. (Then banks charge a 1% fee to the new borrower). You can squeeze them on that and let the lender know that they can pass this fee to their new borrower.
  • Pay Downs: Sometimes deleveraging your assets is important. And having the ability to pay down debt is useful. Lenders may have some stops here. For example, you may not pay down more than 15% of the loan balance in any given year, etc.
  • Personal Guaranty: Some lenders will want a personal guaranty- you can wiggle your way out of this with some lenders; if banks really want the guaranty given the loan’s credit, the borrower may offer a reserve for future debt service.

Like I said, check back regularly for more of your commercial real estate need-to-know questions answered.

Don’t forget to submit your own in the comments below.

(NOTE: Want access to The Commercial Investor business vault? Right now we’re offering access to systems, strategies, templates, trainings, and recordings. It’s all included in The Investors Syndicate, and is available to you here.)

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Peter Kasyanenko
Peter Kasyanenko is a portfolio manager at a New York City-based major U.S. life insurance company, co-managing over $40 billion in commercial mortgages. Peter has also been involved in the underwriting of $5 billion in closed real estate acquisitions, developing strategies for large institutional clients, and tracking real estate capital market activity. Peter resides with his wife, Rachelle, in New Jersey and enjoys an active, outdoors lifestyle.

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Peter Kasyanenko

About Peter Kasyanenko

Peter Kasyanenko is a portfolio manager at a New York City-based major U.S. life insurance company, co-managing over $40 billion in commercial mortgages. Peter has also been involved in the underwriting of $5 billion in closed real estate acquisitions, developing strategies for large institutional clients, and tracking real estate capital market activity. Peter resides with his wife, Rachelle, in New Jersey and enjoys an active, outdoors lifestyle.
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