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Commercial Loan Terms, A General Overview


The following list consists of Key Commercial Loan Terms and Definitions the new or experienced investor should be very familiar with.

Some of the definitions in this list were taken from the book “Commercial Real Estate Finance Basics”, published by Mortgage Bankers Association of America, 2000 by Gary Hutto.

Absorption – the amount of commercial space that the market will use during a specified period of time.
(Application) A developer who understands the meaning of this commercial loan term will need to project what his absorption of his units will be when determining how much debt service he will continue to hold as he sells off his units.

Acquisition Loan – additional capital from either private investors or from a money center such as a bank, savings and loan or a credit union to purchase or take down the land.
For a complete discussion of Acquisition Loans

Assessment District –  is a financing tool available to most existing legislative bodies (cities, counties, special districts), that allows that agency to construct desired and authorized public improvements, with the costs and expenses being apportioned and spread against the benefited properties within the boundaries of a designated area (assessment district), with said costs and expenses being directly proportioned in accordance with the special and direct benefits that each parcel receives from the works of improvement.
For a complete discussion of Assessment Districts

Balloon Loan – any loan that requires a lump sum payment of principal at some time.
(Application)A developer will need to be aware of any final payments that will become due because the loan is not self-amortizing, i.e. paying itself of in equal installments.

Bridge Loan – a short-term financing which is expected to be paid back relatively quickly, such as by a subsequent longer-term loan. It may also be called a swing loan or known simply as bridge financing

Bullet Loan – a variation of a balloon loan requiring payments of interest only, the balloon equals the original balance of the loan.
(Application) A Developer will have to come up with the full amount of the original loan at the end of the bullet period, if he indeed understands the significance of this commercial loan term and therefore must budget accordingly when selling off his units, or have another loan in place to replace the interest only note.

Cap Rate, Capitalization Rate – the capitalization rate is basically the required return on a product.
(Application)A new investor will purchase property based on a cap rate, by analyzing the various prices of property based on cap rate the investor can determine if he is paying a fair price for the investment.
For a complete discussion of Cap Rates

Construction Loans – loans designed to pay for the development phase in stages. By providing collateral, usually by pledging the land (assuming the land is free and clear, which means no debt), the lender will disburse funds according to the schedule of production for the project.
For a complete discussion of Construction Loans

DCR, Debt Coverage Ratiothe ratio of NOI (net operating income) to the anticipated debt service.
(Application)The investor must be aware of whether the loan has a high probability of getting funded. The higher the DCR, the greater likelihood of the deal closing. A low DCR yields a property that is not cash flowing,
For a complete discussion of DCR

Factoringa type of financial service whereby a firm sells or transfers title to its accounts receivable to a company, which then acts as principal, not as agent. The receivables are sold without recourse, meaning that the factor cannot turn to the seller in the event accounts prove un collectible.
For a complete discussion of Factoring

Gross Potential Incomethe total rental revenues of the property, as if the property is 100% leased up.
(Application)The new investor will represent the property’s earning potential at 100% occupancy. Lenders will use this calculation to determine underwriting requirements then reduce the PGI by a standard vacancy factor being applied in that particular market.

Indexin a variable or an adjustable rate mortgage the base interest rate (prime, LIBOR, Fed Funds, T- BIlls, etc.) upon which the loan’s interest rate is calculated.
(Application)By being aware of which index rate is being recommended the investor can determine the volatility of his loan payments, based on the volatility of the index rate selected by the lender.

Leverage is the process of utilizing an investors capital to multiply your individual rate of return due to the fact that you borrowed capital rather than used your own capital to procure the investment.
For a complete discussion of Leverage

LTV, Loan to Value Ratio – the amount of debt as compared to the value of the property.
(Application) The Down payment the developer can come up with will determine the LTV, and therefore will dictate what type of loan programs the investor will qualify for.

Mezzanine Financing a hybrid of debt and equity financing. Mezzanine financing is  basically debt capital that gives the lender the rights to convert to an ownership or equity interest in the project if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies.

Mini Perm a short-term financing used to pay off income-producing construction or commercial properties, usually payable in three to five years.

NOI, Net Operating Income –  is the gross income of the property less direct operating costs, but excluding depreciation, amortization and interest expense.
(Application)The investor’s bottom line is NOI, and NOI will dictate what loan if any will be approved, as well as how much money the investor will have for his discretionary income at the end of the fiscal year.
For a complete discussion on NOI

Rent Measurements; Rent Per Square Foot – annual rent is divided by Square footage

Return on Investment; ROI is the measuring rod that all investors should be using when they are entertaining the purchase of a property.  What return on you receiving on the dollars that you actually invested not borrowed.
For a complete discussion on ROI

SBA Loans are loan that are guaranteed by the Small Business Administration and issued by various financial institutions throughout the United States and are solely used for the acquisition, or expansion of an owner occupied business.  Each of the programs are designed to cover a variety of business, needs, thus providing the most options to small businesses.
For a complete discussion on SBA Loans

Vacancy Ratiothe percentage of the property that is not occupied. The ratio is the quotient of the dollar vacancy divided by gross potential. (Application) BY Being aware of this commercial loan term an investor can determine how much real income he is to derive, but more importantly being aware of what vacancy factor the underwriter will apply will help in determining the feasibility of the financing.