“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner Chapter 20 Commercial Real Estate Finance

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner Major Topics  How does commercial real estate finance differ from residential?  What affects the availability of commercial property financing?  Who are the major providers of commercial property mortgages?  What is the CMBS market and how does it provide mortgage money?  How do lenders underwrite commercial property? Assess risk?  How do borrowers determine where and how to finance a property?  How is the internet changing the business?

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner Introduction Distinctions between financing Commercial properties and Residential financing: 1. Commercial financing transactions are less standardized 2. Transaction amounts are large 3. Loan terms are much shorter 4. Loan documents are customized to the transaction and are heavily negotiated 5. Underwriting emphasis is on the property’s income and value 6. Commercial property loans are not subject to consumer protection laws

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner Introduction (Contd.) 7. Detailed and lengthy loan submissions are specifically prepared for each transaction 8. Prepayment ability is limited 9. The loan approval process is lengthy Commercial Borrowers and Lenders  Individual real estate investors and partnerships  Corporate users of real estate  Real estate developers  Large institutional owners

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner Sources of Debt Funds  Commercial banks are clearly the most important source of commercial property loans  Commercial mortgage backed securities (CMBS) have become the second most important source followed by life insurance companies

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner Process of Securing Commercial Property Financing Step 1: Complete the Financing Loan Application Package Step 2: Package Submission and Solicitation of Quotes Step 3: Loan Application Step 4: Underwriting Step 5: Loan Committee Approval Step 6: Commitment Letter Step 7: Due Diligence and Closing Process Step 8. Loan Closing and Funding

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner Mortgage Underwriting  Loan to Value Ratio (LTVR)  Debt Coverage Ratio (DCR)  Break Even Point  Evaluation of NOI (Completed Property)  Evaluation of NOI (Property to be built)

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner New Directions: Commercial Mortgage Backed Securities  In a CMBS the securities are separated into different classes referred to senior and subordinated tranches  The tranches are rated according to the priority of claims on the cash flow from the properties securing the issue  Those investing in the subordinate classes of the securities will receive a higher interest rate to compensate for their risk  The Z tranche is the residual tranche receiving the lowest priority of property repayment proceeds

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner The Rating Process  Probability of Default based on:  Debt Service Coverage Ratio (DSCR )  Loan to Value Ratio and cross collateralization  Property type and geographic location and market conditions for each property type and geographic market  Expected cash flow volatility (lease structure, market conditions or tenants)  Track record of players

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner CMBS Advantages and Disadvantages for Borrowers and Lenders  Advantage to lender: the sale of mortgages originated allows lenders to reduce and reallocate their direct portfolios of single mortgages  Disadvantage to borrowers: significantly higher transaction costs such as investment banking fees, rating agencies and other professional services  Conduits – entities that originate or purchase loans and hold them until they form a pool that is large enough for a CMBS transaction – are more “user friendly” for the borrower in that the borrower has no involvement in the securitization process

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner The Securitization Process for a CMBS Mortgage  Step 1: Loan Production/ Origination/ Underwriting  Conduits  Government Agencies  Private Portfolio Loans  Institutional Portfolio Loans  Step 2: Mortgage Documentation  Step 3: CMBS Issue Underwriting

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner The Securitization Process for a CMBS Mortgage  Step 1: Loan Production/ Origination/ Underwriting  Conduits  Government Agencies  Private Portfolio Loans  Institutional Portfolio Loans  Step 2: Mortgage Documentation  Step 3: CMBS Issue Underwriting

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner Securitization Process (Contd.)  Step 4: Issue Structuring  Step 5: Credit Enhancement  Step 6: Closing  Step 7: Distribution  Step 8: Servicing  Step 9: Trading CMBS Issues

“Real Estate Principles for the New Economy”: Norman G. Miller and David M. Geltner END