• Commercial Property Loan

    Home Loan BYTES FROM OUR KITCHEN

    Commercial Property Loan is also known as Commercial Real Estate Loan (CRE). It is only used for different business requirements and generates a lot of income, such as office complexes, retail centres, apartments and hotels. The financing, including the acquisition of the land, development and construction of the property, is typically done with the help of commercial property loans.

    Just like the residential loans or home loans , the lenders and the banks are very much active when it comes to offering commercial real estate loans. Along with these, there are insurance companies, private investors, pension funds and some other capital source that give out loans for purchasing commercial property.

    Entities vs. Individuals

    While all the residential mortgages are sanctioned to individual people, the property loans are offered to different entities. These entities include trusts, funds, partnerships, developers, corporations, etc. These entities or business groups are generally formed for a particular purpose of purchasing a commercial property.

    A business entity might not have a credit history or a financial record. In such a situation, the lender might need owners or principals of the particular entity as loan guarantors. So, if there is an event of loan default then the lender will have a person with him who has a credit history and will also be liable to repay the loan amount. A non-recourse loan is a type of loan where the lender does not need any kind of guarantee the in case of a loan default the property or the real estate would be the only thing to be used as recovery.

    Schedules of loan repayment

    A home loan is a kind of amortized loan. In case of a residential mortgage the total loan amount is repaid by monthly instalments over a certain time span called the loan tenure. One of the most popular loan scheme for residential mortgages is the thirty year mortgage plan with a fixed rate of interest. House owners have different option available too, like 15 year tenure or 25 year tenure. If the tenure of the loan is longer, then the monthly instalment payments will be much smaller amounts. However, the total interest that you pay on your home loan will be a pretty hefty amount. Shorter loan tenures has its own advantages and disadvantages. The total interest that you pay is lesser, compared to the amount of longer tenure. But the monthly instalment will be much higher in this case. The loan amount is fully cleared only at the end of the loan tenure. For example, if you have a loan amount of SGD 200,000 for a period of 30 years with a 5 percent fixed rate of interest, then you will be making a total of 360 monthly instalment payments, each of which would amount to SGD 1073.64. Only after making such a payment, all your debt will be cleared out.

    However, when it comes to commercial loans, the tenure ranges between fixed years or lesser to twenty years. Amortization time is also longer than the tenure of the loan. For example, a lender may make a commercial property loan for a period of 7 years with a 30 year amortization period associated with it. In a situation like this, an investor can make the required payments for seven years. This payment will be followed by a final balloon payment which is basically the remaining amount of the loan.

    If an investor has a commercial real estate loan of SGD 1 million, with an interest rate of 7 percent, he would actually pay SGD 6653.02 for all the seven years. The balloon payment or the final one time lump sum payout would be SGD 918,127.64. This amount must be paid off completely at one go.

    The length of a particular loan tenure and the period of amortization will definitely affect the charges for the lenders. Depending up on the strength of the investor’s credit, the terms can be negotiable. Generally, if the repayment schedule is longer, then the interest rate on home loan also goes up.

    Commercial Property Loan

    Loan to Value Ratios

    The loan to value ratios, or commonly as LTV, must be properly understood in order to differentiate between residential loans and commercial loans. It is basically a figure that measures the total value of the loan against the total value of the real estate. The loan to value ratio is calculated by a lender by simply dividing the total amount of the particular loan by the appraised value of property or the price of purchase, whichever is lower. As an example, the loan to value ratio or LTV for SGD 90000 loan on a property that is worth SGD 100000 would basically be 90 percent. The calculation is SGD 90000 / SGD 100000 = 0.9 or 90 percent.

    In case of both residential loans and commercial real estate loans, the borrowers with lesser loan to value ratio qualify for financing rates that are extremely favourable for them. The borrowers who have high loan to value ratio might face difficulty is getting a favourable rate of interest. The reason for this particular thing is that the people with higher loan to value do not get good rates of interest is that a lot of equity is not there in the real estate. Hence, something of this sort is considered to be a risky situation by the lender. People with lower LTVs, however, pose less risk to a particular lender.

    In case of certain residential mortgages, high loan to value ratio may be allowed. On the contrary, the commercial loans with high LTVs are not very common. The specific loan to value ratio is dependent on the category of the loan. For example, the maximum loan to value that can be accepted of a raw piece of land is 65 percent, whereas, the maximum loan to value in case of multifamily construction could be 80 percent. The lenders have no insurance coverage against any default by the borrower. The lender must depend on the actual property that has been pledged as the security.

    Ratio of Debt-Service Coverage

    The commercial lenders also take note of the DSCR (Debt Service Coverage Ratio). This particular ratio compares the net annual operating income of a property to the annual mortgage debt. The annual mortgage debt includes the principle and the interests. This is calculated to understand the ability of a particular property for servicing its debt. As an example, if the net operating income is SGD 140,000 and the value of the mortgage debt service (annual) is SGD 100,000 then the coverage ratio would come up to 1.40. The calculation is SGD 140,000 / SGD 100,000 = 1.4. The ratio of debt service coverage helps all the lenders to decide the maximum loan amount that is based on the property’s cash flow generation.

    If the ratio of debt service coverage is less than one then it suggest that the cash flow is negative. As an example, let us say that the debt service coverage ratio or DSCR is 0.92. This would mean that only 92 percent of the annual debt service can be covered by the net operating income. Generally, almost all the commercial lenders take a look at the DSCRs to ensure that the cash flow is adequate. The minimum ratio of debt service coverage must be 1.25. Lower ratio of debt service coverage can also be acceptable for the loan amounts that have short periods of amortization and also for the properties with a steady cash flow. For any property that has a cash flow which is volatile, higher DSC ratios may be needed. For example, there are hotels which do not have tenant leases for a long term common to the different types of commercial property.

    Interest Rates and Applicable Fees

    The rates of interest that are charged on the commercial real estate loans are more than the rates of interest charged on residential loans. Along with this, commercial property loans generally involve some fees that would add to overall costs of the loan that includes loan application, appraisal, loan origination, survey fees, legal, etc. Some of the fees are supposed to be paid off even before the loan is approved. Some other fees may be applicable on an annual basis. As an example, let us consider that the origination fee (one time only) is 1 percent at the closing time. The annual fee would be a quarter of that 1 percent, which is 0.25 percent, until and unless the total amount of the loan is completely repaid. So, a loan amount of SGD 1 million would cost you an upfront fees of SGD 10000 as origination fee. The 0.25 percent fees, which amounts to SGD 2500 will be applicable on a per annum basis.

    Prepayment

    A commercial property loan might have certain restrictions on the prepayment of the loan amount. These restrictions are there to benefit the lender so that he generates his expected yield and maintains his profit. If a particular lender agrees to settle the amount of the debt before the tenure ends, then they would possibly charge penalties for prepayment.

    Penalties for prepayment – This is one of the most basic penalty charges for prepayment. It is calculated by the multiplication of the specific penalty for prepayment by the present outstanding balance.

    Interest Guarantee – The lender must get a particular amount as interest even if the loan is cleared before it matures.

    Lockout – A lockout refers to a specific period before which there cannot be any prepayments made by the borrower.

    Defeasance – This is basically a substitution for the collateral. If the borrower runs out of cash, he can exchange things like treasury securities for the actual collateral for the loan. However, big penalties might be associated with such a loan pay off method.

    In case of commercial real estate loans, you must find out all the terms of prepayment on the legal documents and then negotiate as much as possible. You must understand all the options that you have that then take a call on prepayment of the loan amount.

    Bottom Line

    A commercial property is basically a real estate that an investor purchases and then leases it out in order to collect rent from the business that is operating in the property. The investment is made with an idea of more cash generation. While evaluating the loans for commercial real estates, lenders consider several factors like creditworthiness of the applicant, collateral, financial statements, loan to value ratio, ratio of debt service coverage, etc.

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