Understanding commercial loan offers

[Charles H.]

Hello,

I am looking into commercial loans to get into multifamily buildings... I am sending out emails to local banks in areas I want to invest. These loans are a bit more tricky than conventional loans and one of the few emails I got made me jumped off my chair... So I'd like to have your opinion.

Type of Loan: Fully Amortizing Fifteen Year Commercial Real Estate Loan

Pricing: 3/3 ARM or 5/5 ARM priced at 350 basis points over the applicable U.S. Treasury Constant Maturity Index. Initial pricing today would be in the range of 5.5% for a 3/3 ARM and 5.75% for a 5/5 ARM.

350 basis point.... what does it mean? Also, do you all guys have to deal with an ARM commercial ? Not really a fan of ARM for conventional so for bigger deal like commercial, it makes me a bit stressed out.

Fee: 25 basis points of the loan amount

25 basis points, aka fee of 25% the full loan amount ?!?!? 

Loan to Value:Up to 75% of the lesser of the purchase price or appraised value of the property. Borrower to have 25% hard equity in the project.

Debt Service Coverage: 1.25x coverage of proposed debt.

Repayment: Principal and Interest payments in an amount to fully amortize the loan over 15 years.

Security:First mortgage and assignment of leases and rents on subject property

Guarantors:Unlimited personal guaranty of all having an ownership interest of 20% or more.

Does it mean I sign with my blood with such statement saying "unlimited personal guaranty" - therefore a really nasty recourse loan?

Maintenance Reserve:To be established for future upkeep of the property

Escrow Account:For property taxes and insurance


Again, these are typical underwriting standards and can be adjusted based on information reviewed during the underwriting process.

Also, no balloon payment? or is it the ARM 3/3 or 5/5 that says balloon in 3 or 5 ?

Any other thing you see in here that makes you wonder...let me know. As of now, I am just checking out banks in Indianapolis area.

Thanks BP community for the help and understanding of these loans.

[Doug Smith]

OK, I'll try not to write a book, but you are asking a lot of questions on this one. Prior to my role now, I was a commercial banker for years and years. I can answer your questions. There are several types of commercial loans. Most commercial banks focus primarily on "C&I" loans...or Commercial and Industrial. These are loans that the federal regulators are most comfortable with. How a business derives its cash flow is the basis of how the loan is classified. If the debt service (loan payments) will be covered from the operating entity that is occupying the building (owner occupied), then it's usually C&I. "CRE" loans, or commercial real estate loans, are loans like the one you are talking about. With a CRE loan, the debt service is covered from rents derived from the property. Properties like apartment buildings, retail centers, etc. Many community banks do CRE loans and might be a good bet. Some commercial loan brokers do CRE loans as well. They are securitized through capital markets and usually have the 10 year balloon with the 25 year amortization like you were speaking of. Usually, community or commercial banks do the 15 year fully amortizing loans that you mentioned. OK, now for the ARM question: "Credit Risk", the risk that you won't pay is only one risk that a bank takes on. On commercial loans, interest rate risk is a huge concern for the bank. In a low interest rate environment especially, if rates go up and a bank has a large loan on the balance sheet, they are sort of "screwed", so they like to do shorter fixed rate periods and float after that to mitigate interest rate risk. 25 basis points (0.25%) is a pretty cheap fee. I always wanted 1% unless it was a strong client. Debt Service Coverage (DSCR) is the inverse of it's consumer equivalent, Debt to Income (DTI). Rather than Debt/Income for DTI calculations where lower numbers are a better risk, DCSR has Net Income/Debt Service, so higher numbers are good. 1.25X is usually the minimum for most institutions. If your income was $100K and your Debt Payments totalled $25K per year (DSCR uses annual figures), then your DSCR is 4.00X. If your debt payments were $75K per year with the same income, then your DSCR would be 1.33X. Most commercial banks are going to require personal guarantees that are joint and several, meaning that if you have partners and you borrow $100K in the name of the business, each of you are liable personally for the entire debt. That is called "recourse". Capital Markets loans described earlier can often do "non-recourse" where you are not personally guarantying the debt, but those are usually on higher amounts. I think I covered it all. Those terms you list are pretty normal. Let us know if you have other questions. Good Luck!