Generally, a property is deemed "commercial" if it is either non-residential or residential with five or more units. A Commercial mortgage is a loan secured by commercial property. CMBS conduit loans often have fairly strict property condition and term requirements due to the fact that the asset must be homologized for purposes of securitization. For example, the defeasance clause type of pre-pay penalty is particularly popular with conduit lenders: according to this type of penalty, the borrower must replace the value of the lender's return with other appropriate securities if he wishes to pay the loan off before the term expires.
Nevertheless, banks and life insurance companies are not particularly competitive for commercial mortgage term loans currently. Many banks have either developed a conduit section, through which they can originate conduit loans for term purposes; or they actually refer term loan requests to an associated conduit lender. Banks generally do remain competitive for short- to mid-term construction commercial mortgages, mini-perm loans, smaller term commercial mortgages (under $2 million), and are still the exclusive source for SBA commercial loans.
Sub-prime lenders and private money lenders offer loans for projects that do not fit into the strict guidelines of the conventional commercial mortgage programs, including bridge loans, loans on unconventional properties, and low credit loans.
As one can guess from its name, the primary purpose of this type of commercial mortgage is to act as a financing bridge between acquisition or development of a property and a permanent, conventional take-out loan. These are short-term commercial loans, usually with balloons between three months and three years.
An example of a bridge loan scenario is as follows: A borrower wishes to purchase a hotel, and is approved for a conventional SBA loan contingent upon two years of successful business operation. In order to fund the purchase the borrower arranges for the seller to carry back 30% of the purchase price, and secures a bridge loan for the remaining 70%. The bridge loan allows the borrower to acquire the property and establish the operating history necessary for long-term financing.
"Bridge loan" is a general term applying to the use of funds rather than the funding source or guidelines. Consequently most private money loans and even conventional mini-perm loans are bridge loans in a sense. Normally, however, the term "bridge loan" is associated with unconventional commercial loan programs, i.e. private- or hard-money programs. For example, because the borrower in the above scenario does not have significant cash equity in the property, he would most likely have to go to a hard money lender and a consequent 11-14% rate plus 3-5 points. If, however, he was able to make a 30% down payment in cash, he might be eligible for a conventional mini-perm loan from a bank (provided his assets and credit were also up to snuff) at 1-3% over prime plus 1 point.
The Small Business Administration was created in 1953 as an administrative branch of the US government assigned to promote and aid the interests of small business. An integral part of the aid the SBA provides is the loans it originates or guaranties for commercial properties occupied by small businesses. SBA loans are intended as a "last-resort" for small business borrowers: in order to qualify from a loan from the Administration, a borrower must have been turned down by at least two conventional lenders. The current volume of loans held by the SBA is approximately $45 billion.
Examples of SBA programs are as follows:
The 7(a) program is a guaranty program—i.e. the loan is originated by qualified lending insitutitions—banks—and guarantied against default by the SBA. The program is mainly for acquisition, has a maximum loan amount is $2 million, a 25-year maximum term, and no more than 2.75% over Prime interest rate for loans of more than 7 years and $50,000. In the words of the SBA: The 7(a) program "serves as the SBA's primary business loan program to help qualified small businesses obtain financing when they might not be eligible for business loans through normal lending channels. It is also the agency's most flexible business loan program, since financing under this program can be guaranteed for a variety of general business purposes. Loan proceeds can be used for most sound business purposes including working capital, machinery and equipment, furniture and fixtures, land and building (including purchase, renovation and new construction), leasehold improvements, and debt refinancing (under special conditions). Loan maturity is up to 10 years for working capital and generally up to 25 years for fixed assets." (http://www.sba.gov/financing/sbaloan/snapshot.html)
A Certified Development Company is a type of non-profit organization set up to promote development in a community. The SBA 504 program is designed to guarantee subordinate loans made by CDCs to qualified small businesses, in conjunction with a low-LTV senior loan from a “private-sector” lender, i.e. a bank. The 504 program is mainly for acquisition of commercial properties occupied by a small business, with maturities of 10-20 years, maximum loan amount of $2 million, and interest rates at "an increment" above the rate on 5 or 10 year treasury issues.
Mezzanine loans have become a common alternative to conventional subordinate financing where the terms of a superior (first position) loan prohibit the placement of junior liens on the subject property. The reason a mezzanine loan remains possible under such circumstances is that a mezzanine loan is not secured by a trust deed on the property, but by stock in the entity that owns the property. If a conventional subordinate loan is in default, the lender cannot take ownership of the property through foreclosure, since the claim against title represented by the superior lien would have to be satisfied before the subordinate lender could take action. If a mezzanine loan is in default and the proper UCC foreclosure is carried out, the lender essentially takes majority ownership on the holding entity, and therefore also controls the property. It can then proceed, for example, to sell the property. The superior lien must still be serviced and paid off if the property is sold, but the mezzanine arrangement gives the lender more flexibility in negative circumstances than it would have with a conventional subordinate loan.
Mezzanine loans present certain complications to the origination process, including restrictions on the structure of the holding company and typically cumbersome paperwork. However there are advantages for both the lender and the borrower: for the lender, in case of default the foreclosure process is relatively streamlined; and the borrower is able to leverage the property to an extent otherwise impossible: 90% CLTV is entirely typical, and some lenders may go up to 95%.
A typical mezzanine loan might be provided by a bank or conduit that is also providing the superior financing for the property, with a term of 3 years and the lender's return being composed of a combination of front- and back-end fees (of perhaps 1% each) plus the 60-day LIBOR rate plus 4% (currently about 8%). Alternately, a hard money lender may offer a mezzanine loan with a similar term, but with a 15% interest rate and higher fees.
A Declining Balance is the "traditional" prepay penalty structure. With this structure, the borrower may repay the loan prior to the balloon by paying a penalty equal to a certain percentage of the loan amount, and this percentage declines over time. For example, for a loan with a 10-year balloon and a 25-year amortization, and 6.5% interest, the penalty might be calculated as:
Loan Amount: $5,000,000
| Year | Balance | Penalty |
|---|---|---|
| 1 | $4,917,446 | 5% ($245,873) |
| 2 | $4,735,378 | 4% ($189,415) |
| 3 | $4,635,102 | 3% ($139,054) |
| 4 | $4,528,108 | 2% ($90,562) |
| 5 | $4,413,950 | 1% ($44,140) |
At year five the borrower might have a window in which there is no prepay penalty, after which the declining balance would start over again. 1- to 3-months before the loan comes to term, the borrower might again be able to pay the loan off without penalty.
Declining balance penalties are still widely used by portfolio lenders—commercial banks and life insurance companies.
Two newer types of prepayment penalties are based on the idea that the lender should be completely insulated from any negative impacts of prepayment. According to a Yield Maintenance penalty, the borrower essentially must make up the difference between the amount of interest that would be earned on the loan if it were carried to term and the amount of interest that would be earned if the lender reinvested the borrower's prepaid principal in treasury securities of the same term. So, in the above example, repaying at the end of year 3, the total amount of interest that would be paid to the lender over the remaining 7 years of the loan term would be $1,976,057. The total amount of interest that would be earned with the $5,000,000 principal on a 7-year treasury security note—say, at 5%--would be $1,750,000. So the prepayment penalty amount would be $226,057.
The Defeasance Clause penalty was developed by CMBS Conduits as a way to control fluctuation in the assets that secure their securities issuances. Under this type of penalty, the borrower must provide the lender with treasury securities in the amount of the value of the mortgaged property. We might assume that a $5,000,000 loan has a 70% loan-to-value ratio, meaning that the mortgaged property is worth $7,142,857. The likelihood of a borrower being able to provide the lender with that amount in treasury securities for 7 years is fairly slim; so we can see by this example that prepayment is thus made extremely difficult if not impossible for most borrowers.
Prepayment penalties will often also involve a Lockout, which disallows prepayment under any circumstances for a period of time.