Chapter 16 - Commercial Mortgage Types and Decisions

Assume you want to purchase a 100,000 square feet office property in downtown Baltimore. You are required by your lender to set aside $0.50 per square foot per year (end of each year) for nonrecurring capital expenditures. Suppose the deposit rate is 2% and compounding frequency is annual. How much would you accumulate by the end of year 5?

$260,202.01

Suppose Howard Realty Group prepaid a 10-year, 6% commercial mortgage loan at the end of three years without penalty. The original loan amount was $500,000. The loan was being amortized with monthly payments and a 30 year amortization schedule. The remaining balance at the end of 3 years was

$480,420

Susan is considering buying a class-A office building in Miami. The acquisition price is $2,500,000. She expects the first-year potential gross income (PGI) to be $300,000. Based on her pro forma analysis, vacancy and collection losses comprise 5% of PGI, and operating expenses and capital expenditures will consume 40% of EGI. The interest rate on her commercial mortgage is 6%, with monthly payments and 25-year amortization schedule. If the lender requires the DCR to be 1.35 or greater, what is the maximum loan amount?

1,638,294.68

Susan is considering to buying a class-A office building in Miami. The acquisition price is $2,500,000. She expects the first-year potential gross income (PGI) to be $300,000. Based on her pro forma analysis, vacancy and collection losses comprise 5% of PGI, and operating expenses and capital expenditures are expected to consume 40% of EGI. The interest rate on her commercial mortgage is 6%, with monthly payments and 25-year amortization schedule. If the lender requires the DYR to be 10% or greater, what is the maximum loan amount?

1,710,000

A multifamily property is acquired at a price of $1,000,000. The loan amount is $750,000. The property's first-year pro forma is as follows: NOI: $75,000, operating expenses: $30,000; capital expenditures: $0, and annual debt service: $60,000. What is the estimated DCR?

1.25

The most common loan term of those listed below on fixed-rate commercial mortgages is ____ years.

10

A shopping mall is acquired at a price of $20,000,000 and financed with a blend of equity and debt financing. Specifically, 60% of the acquisition price is finance by an interest-only first mortgage with an interest rate of 3%. The remaining 40% is financed by the equity investor. The property is expected to generate an annual NOI of $1,500,000. Assume the investor has the option to obtain a mezzanine loan with an interest rate of 10% and a loan amount that is equal to 25% of the acquisition price. The remaining 15% of the acquisition price is financed with equity. What is the increase in the investor's expected return on equity in the first year?

7.08%

Which of the following items are typically included in the lender's due diligence of the loan application?

A careful examination of the in-place leases An analysis of the property's income-generating ability A request for environmental reports

Which of the following statements about Fannie Mae and Freddie Mac are NOT true?

A plan to take Freddie and Fannie private has been approved by the U.S. Congress

Which of the following descriptions of a correspondent relationship is correct?

Commercial mortgage brokers charge a fee for their service. Mortgage brokers help to mitigate the information asymmetry between borrowers and lenders.

Which of the following statements about the debt yield ratio (DYR) are correct?

DYR is not affected by the interest rate or the amortization period of a loan. DYR indicates the lender's cash-on-cash return on its invested capital if it took over ownership of the property

Which of the following statements about defeasance clauses are correct?

Defeasance clauses eliminate the borrower's interest savings associated with mortgage prepayment.

HUD actively participates in the mortgage market by issuing loan guarantees for multifamily mortgages through ____.

FHA

True or false: Commercial mortgage borrowers typically default when their equity in the property is negative.

False; Reason: Commercial mortgage borrowers does not default as soon as the mortgage balance exceeds the value of the property because they expect the value of the property to increase and high cost of default.

True or false: The borrower may be required to deposit a specific amount for legal fees and required third-party reports. These deposits are refundable if the lender decides not to fund the loan.

False; Reason: Such deposits are nonrefundable regardless of whether the lender's commitment is accepted by the borrower.

Financial leverage is frequently used in commercial real estate investments. Which of the following statements about financial leverage are correct?

Financial leverage is used by some investors because of limited financial resources (savings). With respect to the IRR, positive financial leverage occurs when the cost of borrowing is less than the unlevered IRR.

Which of the following options are the main repayment mechanisms used in long-term commercial mortgages?

Fully amortizing loans Interest-only loans Partially amortizing loans

Which of the following statements about HUD are correct?

HUD provides guarantees to lenders for loans used by borrowers to refinance qualified low-income properties. HUD provides guarantees to lenders for loans used by borrowers to purchase qualified low-income properties. HUD initiatives include programs that finance rental housing for the elderly.

Of the following, which is the primary risk that a lender reduces their exposure to through the use of a balloon mortgage instead of a fully amortizing mortgage?

Interest rate risk

Which of the following is a characteristic of a mezzanine loan?

It is secured by the borrower's equity interest in the ownership entity.

Which of the following features describe the promissory note used in commercial mortgage financing?

It is used to create a legal debt. It is usually quite lengthy.

Which of the following type of loan is used to finance improvements to the land, such as sewers, streets, and utilities?

Land development loan

Which of the following are characteristics of a loan syndication?

Lender usually provides a larger loan amount, which is often attractive to borrowers. The group of lenders share the risks associated with a large loan.

Interest rates on floating-rate mortgages have typically been tied to the London Interbank Offer Rate (LIBOR). All else being equal, compared to fixed-payment mortgages and from the perspective of the lender, floating-rate mortgages typically have:

Lower interest rate risk but higher default risk

The debt yield ratio is defined as

NOI in the next year divided by the loan amount

Which of the following are usually contained in a commercial mortgage loan submission package?

Size of property pledged as collateral Requested loan amount

True or false: If a property performs poorly, the use of financial leverage can make a bad situation worse.

True

True or false: When a property is sold before the loan term ends, commercial mortgages do not allow transfer of the mortgage liability from the original borrower to the buyer of the property without the approval of the lender.

True

When is a borrower likely to purchase a rate lock agreement on the loan before its closing?

When interest rates are likely to increase after the loan commitment is made but before closing

In recent years, lenders have been unwilling to relieve borrowers from personal liability in the event of fraud, environmental problems, or unpaid property tax obligations. A clause that holds the actual borrower liable in such instances is commonly referred to as: Multiple choice question.

a bad boy clause

Prepayment penalties are typically expressed as

a percentage of the remaining mortgage balance

The due diligence process normally occurs

after the signing of the loan application

With a balloon mortgage, the remaining mortgage balance at the end of the loan term must be satisfied by the borrower. The borrower's options do NOT include

allowing a different investor to assume the loan

Potential outcomes of the lender's discovery of inconsistencies or errors in the loan submission package include:

an alteration of the loan terms a refusal to fund the loan a reduction in the loan amount

A borrower can increase his or her financial leverage by applying for a second mortgage, which is secured by the borrower's pledge of the property as ____ for the loan.

collateral

Which of the following lenders is more likely to require some from of credit enhancement on a commercial real estate loan?

commercial banks

With a yield-maintenance agreement, if the borrower prepays she will have to pay a penalty that is tied to the extent to which mortgage interest rates have ____ since origination.

declined

All else being equal, floating-rate mortgages ____ the lender's interest rate risk.

decrease

All else equal, when the DCR ratio increases, the likelihood of default by the borrower ____.

decreases

As the use of financial leverage increases, the probability that the property will be "cash flowing" ____.

decreases

The yields on commercial mortgages have been approximately 2 percentage points higher, on average, than the yields on comparable maturity Treasury securities over the past 20-plus years. This lending spread primarily represents compensation to the lender for expected:

default risk

With a participation mortgage, the lender participates in cash flows that are generally received only by the:

equity investor.

When a lender forecloses on a mortgage loan, the ____ lien holder is entitled to the foreclosure sales proceeds before the ____ mortgage holder receives any of the proceeds from sale.

first; second

Mortgage brokers

get paid a fee for helping borrowers and lenders find each other.

Payments on commercial mortgage loans are expected to come primarily from:

income generated by the property pledged as collateral

Typically, financial leverage alters the risk-return relationship of real estate investments by:

increasing the expected IRR on equity. increasing default risk.

No principal reduction occurs from one month to the next with

interest-only mortgages

A rate lock agreement:

is purchased by the borrower for the benefit of the borrower may result in a lower contract interest rate than if the rate is not locked

Due-on-sale clauses primarily protect the ____.

lender

On a partially amortizing loan, monthly payments are based on an amortization term that is ____ the actual term of the mortgage loan.

longer than

Recently, loans on retail properties have been associated with higher delinquency rates. Assuming this trend is going to continue in the near future, lenders will likely to require ____ LTVs on such loans.

lower

The ____ the LTV, the lower is the likelihood of default, all else equal.

lower

The use of financial leverage amplifies the expected IRR on investors' equity. This ____ of equity returns is known as financial leverage.

magnification

Relative to conventional mortgages, bridge loans are ____ from the lender's perspective and therefore carry ____ contract interest rates.

more risky, higher

The majority of bridge loan financing is provided by ____.

non-traditional lenders

Typically, a lockout provision is adopted to ____ prepayment of the remaining mortgage balance for a certain period of time.

prohibit

When mortgage lenders have access to other borrower assets in situations where the foreclosure sale price is less than the total amount owed the lender, we commonly refer to this type of loan as a

recourse loan

Reducing the term of a fixed rate mortgage from 30 years to 10 years but keeping a 30-year amortization schedule:

reduces the lender's interest rate risk

Lockout provisions, defeasance clauses, prepayment penalties, and yield-maintenance agreement are employed to restrict borrower's prepayment when mortgage rates are declining. They all reduce the lender's ____.

reinvestment risk

The contract interest rate on floating rate commercial real estate loans is typically tied to movements in

short-term interest rates

Larger loans typically have contract interest rates that are ____ the rates on smaller loans.

slightly lower than

When the contract interest rate is not locked via a rate lock agreement

the borrower and lender will usually agree to a fixed spread over the benchmark interest rate (such as the yield on 10-year Treasury securities)

In commercial mortgage financing, a note contains the terms of the loan and provisions agreed to by the borrower and lender. Typically, the provisions of the promissory note cover matters such as

the borrower's responsibility for maintenance of the property what happens if the borrower defaults the amounts and timing of periodic payments the penalties for late payments

The "price" of purchasing higher expected returns with more financial leverage is

the increased variability of the return on equity

Relative to home loan underwriting, the underwriting of commercial real estate loans is more focused on:

the property pledged as collateral for the loan

Financial risk is the risk that NOI will be insufficient to cover the mortgage payment obligation. Therefore, financial risk is most closely linked to:

the risk of default

Borrowers with negative equity often continue to make mortgage payments because:

they are waiting for the value of their property to increase

Land acquisition, development, and construction loans:

usually have floating interest rates are usually prepayable at anytime without penalty