Commercial real estate loans can vary widely from lender to lender, and there are four main types commercial real estate lenders you should know about before taking on debt at a property. This video will break down who these commercial real estate lenders are, and the key characteristics of each.
Hey, this is Justin from BreakingIntoCRE.com and in today’s video, we’re going to talk about four different types of commercial real estate lenders and the different characteristics of each. So if you’re thinking about buying a commercial real estate property and want to know what your different debt options are, stick around for this video. Now, if you’re new here on this channel, we talk about real estate investing careers and real estate financial analysis. So if you’re looking to break into the industry, or do your first real estate investment deal, make sure to subscribe and hit the notification bell.
Now commercial real estate loans can come from a lot of different places, but there are really four main players in commercial real estate lending. So in this video, I’m gonna break down who these lenders are, and how these lenders differ from one another, and what might be the best option for you based on your specific situation.
So let’s start this off with option number one, and this is a very common option, and that is commercial banks. Now these can be big banks that you know very well, like Chase, Wells Fargo and Bank of America, but also smaller local banks and credit unions as well. Now, these commercial banks get their funds from depositors. So just like you and I would go to a bank and deposit money in a checking or savings account, these lenders turn around and then lend that money out to commercial real estate investors and earn interest on that money that they lent.
Now these lenders are often referred to as Balance Sheet Lenders because they keep these loans on their balance sheet rather than selling these loans on the secondary market. Now, with banks, you’re likely to see more recourse loans than nonrecourse loans, meaning that the borrower is going to be on the hook for any unpaid loan balance if the borrower can’t pay off that loan with sale or refinance proceeds. But because these loans are recourse, and the loans are held on the bank’s balance sheet, oftentimes banks can be much more flexible on terms than other lending options in the market.
Bank financing also tends to be very relationship focused as well. So as you build a relationship with a bank over time, you’re able to negotiate things like longer interest only periods, waiving prepayment penalties, and other advantageous terms that come with doing business again and again with the same shop.
Now aside from banks, another common lender in commercial real estate is insurance companies. Now these groups like MetLife, Prudential, and New York Life get their funds from policyholder premiums and then lend that money out into the market into commercial real estate deals. Now, life insurance company lenders have historically been a great source of long term fixed rate nonrecourse debt.
These companies will often make large, low risk, conservative loans on what many commercial real estate professionals refer to as ‘large trophy case assets’ like high rise, Class A office buildings, successful major retail centers, and well known luxury hotels in major cities. And since these insurance companies are generally nonrecourse lenders, they’re very focused on the performance of the specific property that they’re lending on much more than the borrower’s personal balance sheet or the balance sheet of the company.
So for companies like these, most of the analysis done on the borrower is around the track record of the company and or the key principles on the borrowing entity, and the company’s overall portfolio, and the leverage on that portfolio as well. And since the focus for insurance companies is generating stable long term cash flow over an extended period of time, these insurance companies tend to issue low leverage loans and also underwrite extremely conservatively to make sure that they maximize the chances of not losing money on any loan that they issue.
Commercial Mortgage Backed Securities (CMBS)
Now from here, since we talked about banks and insurance companies, next up we have commercial mortgage backed securities, or CMBS. Now CMBS loans are much more strictly regulated than you’ll see from banks or insurance companies, and borrowers of CMBS debt must be single purpose entities, or SPE for short, which are LLCs or corporations which have no other assets other than holding title to the property.
Now, CMBS lenders securitize these loans by pooling a large number of mortgages into a single security and then selling pieces of that security to the public market. And because that security is sold in the public market, that means that there needs to be much more strict regulation on these loan structures. So while banks and life insurance companies can be much more relationship based with the terms that they offer, CMBS lenders tend to be much more transactional and rigid with the loan structures they offer.
One area in particular where these regulations have a big impact on borrowers is the ability to prepay a CMBS loan. In fact, many CMBS loans have lengthy prepayment lockout windows where the borrower isn’t able to prepay that loan at all during that time. And even when that lockout period has burned off, there are also generally hefty prepayment penalties associated with pre-paying a CMBS loan before as early as six to nine months before that maturity date. And this makes sense because the investors in that security expect a certain fixed rate of return for the entire life of their investment.
And because of this, these prepayment penalties often incorporate either a yield maintenance or defeasance provision, which essentially attempt to make up that loss yield that the investor would have otherwise received if that loan wasn’t prepaid before loan maturity. Now, these can be extremely costly to a borrower. So when you’re looking at CMBS loan options, you need to be fairly certain that you’re going to want to hold that property and keep that loan for the entire duration of that loan term.
Now, CMBS loans are nonrecourse meaning that the lender can’t go after the borrower’s personal assets in order to pay off the loan balance in full every finance or sale. With that said, there are certain bad boy carve out provisions which turned the loan into a recourse loan if the borrower is involved with anything like fraud, bankruptcy, or subordinate financing without the consent of the lender.
And then finally, from here, another highly regulated option is going to be your agency financing from companies like Fannie Mae and Freddie Mac. These lenders are government sponsored enterprises, or GSEs, which were initially established to spur certain sectors of the American economy, in this case, residential housing.
These lenders fund loans on multifamily properties and are often able to offer extremely competitive terms that many other multifamily lenders like banks and insurance companies just can’t match. But with that said, just like CMBS options, agency loans tend to be extremely regulated and standardized compared to a bank or insurance company option.
This is because like other CMBS options, these loans are packaged up and then sold in the secondary market. This means that you’ll often see the same kind of prepayment penalties like yield maintenance and defeasance, which can be extremely costly if you prepay the loan. With agency lending, you’ll also likely see non recourse financing with those same bad boy carve outs that you’ll see in a CMBS option.
It’s also important to note that Fannie Mae and Freddie Mac don’t directly select the projects that they’re going to lend on, but rather partner with private lending institutions that follow strict agency guidelines. These companies that originate loans on behalf of these agencies are referred to as designated underwriter servicers or D U. S for short. And as the name implies, these firms will also service the loans meaning that they’re going to be interacting with borrower and collecting payments on a monthly basis.
So instead of interfacing directly with Fannie Mae or Freddie Mac, multifamily borrowers that go the agency route will work through well known private firms like Wells Fargo, Walker and Dunlop, Acadia and CBRE. And again, these agency loans are often most competitive on pricing. So for multifamily investors that can fit those guidelines, agency financing can be a great option to choose.
So if you’re looking for commercial real estate financing, those are really the four main options that you can choose from, and the pros and cons and differences between each. So I hope that was helpful. As always, if you want to learn more about any of this, make sure to check out Break Into CRE Academy and I’ll link that in description below. If you like this video and want to see more content like this, make sure to hit that like button, subscribe to the channel, and share this with anyone else who might find this helpful. Thanks so much for watching, and I’ll see you in the next video.
Transcribed by https://otter.ai