Key Terms in Commercial Mortgage Loan Commitments

You are in escrow to acquire a commercial office building (or other real estate). Due diligence results show the property will be a solid investment. Rather than put all cash into the deal, you’ve elected to seek financing for the acquisition and you’re about to meet with a commercial real estate mortgage lender or broker. Below is a list of key terms you’ll be discussing. To help you with that meeting, this article briefly discusses some of these key terms.

Loan Purpose:

Will you need funds just for the acquisition or will you be constructing improvements to enhance the marketability and value of the property? Your answer will impact the interest rate and repayment terms.

Loan Amount/Equity Investment

While most lenders would be comfortable lending 70% of the appraised value of the property, the remaining 30% would be cash which the lender would expect/require you to invest in the transaction. Be sure to ask yourself this question: at a 70% loan to value ratio, does the property have sufficient cash flow to service the loan debt, pay property taxes, insurance, other operating expenses (not reimbursed by your tenants), and provide a reasonable return to you and your partners?

Loan Terms

When will the loan be due? Will you have an option to extend the maturity date? What annual interest rate will apply to the unpaid balance? Will it be fixed or variable? Expect to make monthly payments and will they be interest only or principal plus interest? Will the loan self-amortize over its terms or will there be a balloon payment due at the maturity date?

Collateral

Expect the lender to ask for a first position mortgage (or deed of trust) encumbering the real estate along with a security interest in all personal property and contract rights coupled with an assignment of all lease rights.

Prepayment

Will you be able to prepay the loan before maturity? If so, will there be a prepayment penalty or fee?

Assumption

If you sell the property, will your buyer have the ability to assume your position as the borrower? Thus to complete the sale, your buyer won’t have to look for new financing. Upon such assumption would the lender release you from further liability?

Guarantors

If the property will be owned by a legal entity (such as a limited liability company or limited partnership), expect the lender to require personal guarantees from the principals and their spouses.

Recourse or Non-Recourse Loan

In a recourse loan, the lender can foreclose on the real estate and pursue the borrower (and any guarantors) personally for any deficiency (loan balance less the amount realized at foreclosure). If the loan is non-recourse, the lender cannot pursue the borrower. One wrinkle: expect the lender to ask for non-recourse carve-outs supported by a non-recourse carve-out guaranty.

This means if the borrower commits fraud, absconds with insurance or condemnation proceeds, fails to apply reserved money (see discussion below) for pre-determined expenses such as maintenance or repairs, then both the borrower and the guarantors would be personally liable to the lender for damages lender suffers due to such bad acts.

Loan Fees

Expect to pay certain fees which may vary from loan to loan and from lender to lender. Typical fees include a loan commitment fee, loan application fee, lender’s legal fees, and a termination fee if you elect not to go forward with the loan.

Loan Reserves

Lender will likely require a monthly deposit in an account(s) with a specified bank (if not the lender itself), for: (a) tenant improvements and leasing commissions in connection with new tenants, (b) capital repairs and improvements, (c) rent reserves regarding tenants who have signed leases but have not yet occupied their premises or have not yet begun paying rents, and (d) a lease up reserve into which borrower would deposit monthly the difference between the amount the property would cash flow at 95% occupancy (assuming tenants were paying a minimum agreed upon amount per square foot per year and assuming each tenant would have a minimum lease term of three years) versus cash flow at the actual occupancy level.

Conclusion

Although there will likely be other key terms to discuss such as whether you may place junior debt on the property, whether you can lock-in the interest rate before loan closing and funding, whether you may self-manage this property or must hire a third-party approved manager, and what periodic financial reports will the lender ask you to provide, those topics and the terms discussed above are likely the key ones to be addressed.

About the Author

Roger K. Spencer received his undergraduate degree from the University of Michigan in Ann Arbor, graduated from Northwestern University School of Law in Chicago and for many years was a senior partner in the real estate department of Quarles & Brady (formerly Quarles & Brady Streich Lang) before starting his own firm in early 2005. Roger is an accomplished practitioner with more than 35 years of experience in commercial transactional real estate law with a heavy emphasis on commercial leasing, commercial acquisitions and sales, and commercial real estate finance. He is also an accomplished speaker and lecturer on real estate law topics.

From The Author

If you have any questions on the above article, please contact me and I’d be happy to discuss those questions with my compliments. Also, as a courtesy to visitors to my website, I would be pleased to provide a presentation to the real estate personnel on your staff regarding topics of interest involving real estate law issues.