1. Chapter 19 Permanent Financing of Commercial Real Estate Properties

2. Chapter 19 Learning Objectives n Understand how concepts such as agency problems, interest rate risk, and leverage apply to permanent commercial property financing n Understand the differences between permanent commercial property finance and residential or acquisition, development, and construction finance n Understand how equity participation loans are structured n Understand the lease-versus-own decision n Understand the mechanics of a sale-leaseback

3. LONG-TERM, FIXED-RATE LOANS n Commonly used to finance commercial real estate n Originated by financial institutions, life insurance companies, pension funds n More complex underwriting and lower LTV ratios than residential loans n Prepayment penalties n Assignment of rents

4. EQUITY PARTICIPATION LOANS n Lender offers a lower interest rate for a share of the income and/or price appreciation of the property n Increased risk for the lender in giving up interest n Decreased risk for the borrower through lower interest n Discount rates should reflect risk levels

5. LEASE VERSUS OWN n Owning: Interest is tax-deductible, can depreciate, receive price appreciation n Leasing: no down payment, avoids expense of incurring debt, tax deduct the lease payments, no price appreciation n IRS may consider the lease to actually be a financing arrangement

6. SALE-LEASEBACK AGREEMENTS n Sell the property and simultaneously lease it back from new owner n Satisfies immediate for cash while retaining use of the facility n Seller may agree to repurchase at end of lease period at a guaranteed price or indemnify the buyer if property prices fall and option to buy is not exercised

7. LEASES AND ACCOUNTING REGULATIONS n Operating lease is a normal business lease n Capital lease is a substitute for debt financing. Criteria: n Transfer of ownership n Option to repurchase n Lease term is >= 75% of asset life n PV of lease pmts = 90% of asset value

8. GROUND LEASE MORTGAGES n Land is not owned but leased from owner for development n Most common in dense populations n Ownership of improvement passes to land owner at expiration of lease n Leases are long-term (maybe 50 years) n Sometimes treated as real property

9. CREDIT-BASED FINANCING n Uses the tenant’s good credit rather than the real estate as basis for financing n Tenant’s credit stronger than landlord n Multisite securitization - a pool of facilities is net leased to the tenant n Tenant improvement financing with a personal property lease