Commercial Real Estate CMBS Conduit Loan Program Retail Medical Office Industrial Warehouse Hotel Apartment Mixed-Use Self-Storage City Capital Realty Shawn Rabban 310-714-5616 shawnrabban@yahoo.com CAL BRE. 00667328 NMLS. 298861 / 729817 "California Bureau of Real Estate, Real Estate Broker "
CMBS Conduit Fixed Rate Loan Program This outline contains the current general parameters of the lending program. The program contains additional details and requirements that are not included in this summary. All program requirements and underwriting criteria are subject to change by lender without further notice. Nothing contained herein is Property Type Retail, Industrial, Office, Medical, Warehouse, Self-Storage, Mixed-Use, Multifamily Loan Amount $5,000,000 to $500,000,000 Loan to Value Up to 75% Amortization Term Debt Coverage Ratio Interest Rate Index Spread Up to 30 years 10 years 1.25x minimum Fixed for 10 years 10 years treasury bill Vary Origination Fee 1.00% Security Recourse Assumption Subordinate Financing Lock-Out Period Pre-payment Penalty Escrows Final three months Closing Cost First Mortgage Non-recourse subject to standard carve out Yes, Generally not allowed First three years Defeasance Required for property tax and insurance There is no pre-payment penalty Borrower to pay normal and customary closing costs that include: third party reports, title insurance, escrow, appraisal, engineering inspection, recording fees, and lender s legal counsel, survey costs, intended to be, nor should it be construed as, a commitment to lend on these or any other terms. Terms and conditions are subject to change without notice. Some restrictions may apply. 2
A Commercial Real Estate CMBS Conduit Loan Program is a permanent fixed-rate mortgage that is designed as a non-recourse loan according to specific underwriting guidelines. Conduit Loan programs are available for many income producing property including: Retail Apartment Office Industrial Medical Hotel Self-Storage Warehouse Mixed-Use When working with City Capital Realty., you can feel confident that our professional mortgage staff will fulfill your needs and exceed your expectations. We are available to answer all your questions and concerns. Part of our continuing goal is to provide our clients with excellent service. Our focus and passion throughout the loan process is you, our clients. With you in mind, we take each of our loans personally, working through problems and providing solutions, becoming as concerned over the loan as the person we are working for. Once you have discovered your mortgage needs, allow us to take away your worries and make them ours. CMBS Conduit Loans are relatively new in the market. CMBS Conduit Loans are designed to pool your loans with other similar assets to sell in secondary market. Most securitized loans will have balloon payment provisions at the end of the fixed rate term that you will need to refinance. However, because the underwriting criteria and due diligence are fairly stringent for non-recourse loans, the interest rates tend to be more attractive compared to convention loan programs. 3
CMBS Conduit Loans are designed to remain in place for the life of the note to ensure the marketability of the securities created when they are pooled together and sold. A few things to keep in mind before you obtain a CMBS conduit loan. Usually, CMBS conduit loans change hand a few times during the term of loan that is normally 10-year period. It will be a good idea to negotiate the loan documents contents in advance because it will be beneficial to future buyers if you decide to sell your property in the near future. City Capital Realty can arrange special provisions on loan documents regarding assumption clause through its own legal consul.50% assumption fee for first time.75% assumption fee for second time 1.00% assumption fee for third time. With City Capital Realty Conduit Loan Program, you can have multiple entities to be recorded on the title. Sometimes it is necessary to have different entities on the title, because investors come from different exchanges or they might want to do future exchange on their own. 4
Exhibit A Example of Income Producing Property Gross Scheduled Rents $100,000 Less 5% Vacancy Amount < 5,000> Effective Gross Income 95,000 Less Operating Expenses <30,000> Net Operating Income 65,000 Cap Rate 7.6% Property Value 850,000 Down Payment: 30% 255,000 Loan Amount: 70% 595,000 Rate 6% x 25 yr (yearly payment) 51,122 Cash Flow 13,878 Debt Coverage Ratio 1.27 Loan to Value 70% Return-on-Investment 5.4% 5
Please note that lenders always insist on some sort of vacancy factor regardless of the actual vacancy rate in an area to cover collection loss. In addition, lenders always insist on using a management factor of 3-5% of effective gross income even if the owner is managing the property. Operating Expenses include the following items: 1. Property tax 2. Insurance 3. Management 4. Maintenance 5. Repairs 6. Supplies 7. Reserve 8. Miscellaneous NET OPERATING INCOME (NOI) Net Operating Income is the property s gross income plus any other income, such as parking income less vacancies. Essentially, NOI is the net cash generated before mortgage payments. Net Operating Income is calculated like this: Gross Scheduled Income $100,000 Less: Vacancy Amount 5,000 Effective Gross Income 95,000 Less: Operating Expense 30,000 Net Operating Income 65,000 Net Operating Income is one of the most important factors. Capitalization rate is used to estimate the value of income producing property. Let s assume7.6% is capitalization rate for this type of property that you are considering to buy. A market cap rate is calculated by evaluating the financial information from comparable sales data of similar income producing properties in the same market area. 6
We would estimate value of this property like this: (See Exhibit A) Example 1: A property has NOI of $65,000 and cap rate of 7.6% Estimated Value = Net Operating Income = $65,000 = $850,000 Cap Rate 7.6 Example 2: A property has a NOI of $65,000 and asking price is $850,000 Cap Rate = Net Operating Income = $65,000 x 100 = 7.6 % Market Value 850,000 The cap rate may vary in different areas of city for many reasons such as desirability of location. You should expect lower capitalization rates in newer or more desirable areas of city and higher cap rates in less desirable areas. The most important ratio to understand when making income property loans is the debt service coverage ratio. It is defined as: DSCR = Net Operating Income = $65,000 = 1.27 Total Debt Service 51,122 DSCR of 1.27 times as much annual income as the annual debt service on the property in this example, the property creates 27% more income than is required to cover the annual debt service. DSCR of 1.0 is called a break-even cash flow. That is because the net operating income is just enough to cover the mortgage payment (debt service). DSCR of less than 1.0 would mean that there is only enough net operating income to cover 90% of the mortgage payment. This would mean that borrower would have to come up with cash out of his personal budget every month to keep the project going. Lenders use debt coverage ratio (DCR) to determine if income-producing property has sufficient income to cover the operating expenses and debt services. Cash on Cash Return is probably the most important ratio you need to focus on when evaluating the long-term performance of a property investment. Cash on Cash Return is the property s annual net cash flow divided by net investment, expressed as a percentage. First Year Cash Flow = $13,878 = 5.4% Down Payment 255,000 7
Loan-to-Value Ratio The loan-to-value ratio is calculated by dividing the loan balance of a property by the market price. For example, a property with a loan balance of $595,000 and market price of $850,000 has a loan-to-value ratio of 70%. Loan-to-Value Ratio = Loan Amount = $595,000 = 70% Market Price $850,000 The loan-to-value ratio formula can be used to estimate the amount of equity you have in a property. The Loan-to-Value (Ltv) ratio is probably the most important of the three underwriting ratios. Commercial Real Estate Financing is underwritten on a case-by-case basis. Every loan application is unique and evaluated on it s own merits. But there are few common criteria lenders look for in commercial loan packages. 1. Credit Worthiness Lender will examine your credit history to help determine your willingness to repay a loan. They consider your past repayment performance to be the best indication of willingness to pay on time in the future. 2. Property Property analysis (age, location, condition, type of property) will affect the risk. 3. Loan-to-Value The loan-to-value ratio is probably the most important of the three underwriting ratios. 4. Debt Coverage Ratio A key component in making an underwriting evaluation. 5. Net Operating Income Net Operating Income is the income from a rental property after deducting from real estate taxes, fire insurance, repairs and other operating expenses. 8
How your Loan Request will be reviewed: When reviewing loan request, lender is primarily concerned with repayment. Mortgage consultant judge loan applications based on what is commonly referred to as the five C s of credit. 1. Character Lenders will order a copy of your credit report and look at debt repayment trends. They want to know simply if you pay your bills on time. 2. Cash Flow Lenders will look at historical and projected cash flow statements to determine whether you will be able to repay the loan. 3. Collateral Collateral is an asset which a lender my claim to satisfy a loan in the event the loan isn t repaid. 4. Capitalization Capitalization refers to the basic resources of the company including owner s equity. 5. Conditions Factors that affect the success of investments. 9
Yield Maintenance vs. Defeasance Yield Maintenance Yield Maintenance is an actual pay off of the existing loan. There has been no standardization of yield maintenance language. There is always a minimum prepayment penalty of at least 1% of the loan balance. Yield maintenance is a prepayment of the loan with cash. Defeasance Defeasance is a substitution of collateral. A portfolio of qualified U.S. Government obligations is structured such that it will produce sufficient cash flow to make all remaining payments due under the note as and when the same come due. The securities are pledged to the lender in exchange for the lender s release of the real estate from the lien of the mortgage. Conduit loan defeasances involve a number of parties, require a number of deliverables, and generally take about thirty days to complete. Defeasance is a 30-day process involving a substitution of collateral. There has been a high level of standardization of defeasance provisions. 10
-Loan Glossary- Capitalization Rate A method used to estimate the value of a property based on the rate of return on investment. In real estate appraisal, capitalization is the process of converting income. In the case of real estate, we divide net operating income by a property value. In general, the lower the cap rate the better if you are selling and the higher the cap rate the better if you are buying. CMBS Is an abbreviation for Commercial Mortgage-Backed Securities Common Area Maintenance (CAM) Tenant is responsible for payment or reimbursement of common area maintenance (CAM). Dark Space Vacated retail space. Tenant may still be paying rent but induced smaller tenants may exercise right to cancel leases with the major tenant goes dark Grocery Anchor Retail A retail property in which one or more tenants including a grocery anchor tenant occupy the property. Gross Income Total income, before deducting taxes and expenses. Index An economic indicator, usually a published interest rate, e.g. prime rate, treasury bill, libor, MTA. Prepayment Penalty A fee charged by the lender to allow the borrower to retire the loan earlier than its stated maturity. Rating Agency 11
Rating agencies are private companies that rate the credit worthiness of bond. Real Estate Investment Trust A business entity formed to invest in real estate mortgages or securities backed by real estate. REIT is required to pass through 95% of taxable income on their investors and is not taxed at the corporate level. REMIC Trust Remic is and abbreviation for Real Estate Mortgage Investment Conduit. A REMIC Trust is the entity to which a lender transfers its loan when they securitized them. Replacement Reserves Monthly deposits that a lender may require a borrower to a reserve in an account. Securitization Refers to the process by which a lender transfers loans to REMIC Trust. Tax & Insurance Impound Monthly deposits that a lender may require a borrower to a reserve in an account. Tenant Improvement The expense to improve the property to attract new tenants for a new space that may include new improvement. Unanchored Retail A retail property in which multiple tenants of which none are anchor tenants occupy the property. Yield Maintenance A prepayment premiums that allow investors to attain the same yield as if the borrower made all scheduled mortgage payment until maturity. 12
The Defeasance Solution Rising Property Values drive the need to defease Defeasance is a key to unlocking CMBS conduit loan prohibitions An increasing number of property owners want to remove their existing liens from their properties whose mortgages have been securitized. 13
Conduit borrowers buy and sell properties, so there will always be demand for a mechanism that allows for mortgage repayments. In simple terms, defeasance is the process of retiring a mortgage before its maturity by replacing its collateral. With defeasance, a borrower can get out of a CMBS Conduit loan, which typically has strict prepayment penalties, by replacing the collateral with a basket of treasuries, or other government securities. The loan is technically still in place but is repaid from securities purchased. Typically, the borrower pledges U.S. government obligations as substitute collateral for the loan to the trustee and the transfer of the loan and assigns the substitute collateral to unaffiliated special purpose entity (SPE) created for the sole purpose of receiving defeased loan. A loan is defeased only at the request of the borrower. Generally, the borrower must provide the lender with at least 30 days written notice of intent to defease a loan. The borrower must have a sufficient amount of cash to purchase U.S. government obligations that will timely pay all scheduled interest and principal. In addition, the borrower must also pay all related costs and expenses. Once the collateral is substituted, the borrower is usually replaced. The borrower has effectively prepaid the loan. A defeased loan secured by U.S. obligations is less risky collateral loan than a loan secured by Commercial Real Estate. The original borrower and the real estate may be fully released from all liability with respect to the loan. Although the Internal Revenue Service has not ruled on the tax implications of a conduit loan defeasance, Revenue Ruling 57-198 allows penalty payments made by a taxpayer for the privelege of preparing mortgage indebtedness to be deducted as interest under Internal Revenue Code. Because the defeasance premium is a necessary cost of the defeasance in excess of the outstanding balance on the loan, it appears to be in the nature of prepayment penalty that is deductible from the borrower s taxable income. Consult with your financial advisor. 14
U.S. CMBS: Defeasance Benefits Borrowers and Investors Cost of Defeasance The largest component of the cost to defease is the cost of the U.S. Government Securities that serve as the new collateral for the loan. Therefore, the cost to defease is dependent on a number of factors including: 1. Spread between the mortgage rate and treasury rates. 2. Yield curve at time of defeasance. 3. Amortization of the loan. 4. Remaining term on the mortgage. In general, the cost of the replacement securities referred to as the defeasance premium, REMIC Regulations preclude loans from defeasing until after the second year of a transaction s start-up date therefore, there are no defeased loan until year two. A prepayment option with no penalty typically permitted for a brief period. Perhaps three months, prior to loan maturity. This is an acknowledgment of the difficulty of closing on a new loan or selling a property exactly on the date the loan matures. Overview Many of the structural features in Commercial Mortgage Backed-Securities (CMBS) transactions were designed so that payment streams in CMBS would resemble payment streams from corporate bond issuance as much as possible. This helped the CMBS market top into the large and established corporate bond investor bare and provided a means for investors to include real estate collateral in their fixed income portfolios. One of the key features of corporate bonds is predictability of cash flows. In general, most issuers of corporate debt are precluded from redeeming bonds prior to their stated maturity. Fixed rate loans originated for CMBS also generally limit the borrower s ability to prepay before loan maturity. This ensures CMBS investors a more predictable income stream throughout the life of their security. 15
However, borrowers desire flexibility to refinance or sell prior to loan maturity, resulting in the development of different forms of prepayment mechanisms. The most typical options include prepayment premiums; yield maintenance and most recently, defeasance. Defeasance has emerged as the preferred alternative for handling prepayment in CMBS. It has strengthened the predictability of CMBS Conduit loan payment streams for investors while providing borrowers with flexibility in selling or refinancing their properties. The largest component of the cost of defeasance is the purchase of the U.S. Government Securities that serves as replacement collateral for defeased loan. Defeasance Defined Defeasance involves substituting real estate collateral with a portfolio of U.S. Treasury or agency securities designed to exactly match the cash flow of scheduled mortgage payments, including the balloon payment. The mortgage loan remains in the trust but the real estate originally served as collateral for the loan is released. Defeasance is a positive feature in CMBS Conduit loan for several reasons: 1) First, loan s probability of default is significantly reduced when real estate assets are replaced by US Treasury Securities, thus improving the credit characteristics of CMBS transactions that contain defeased loans. 2) Second, defeasance assures that investors receive the expected income stream until loan maturity. This is especially important in transactions with interest only (10) bonds or bonds purchased at premiums where yield can be significantly affected by early prepayment. Finally, defeasance provides borrowers with the ability to access accumulated equity in their real estate prior to loan maturity. Defeasance is prevailing CMBS prepayment option Yield expectations are generally based on the timely payment of interest and principal from the underlying loans in a pool with some allowance for prepayment due to defaults or early pays offs. The dominant prepayment provision used in both securitized and non securitized commercial loans were prepayment premiums and yield maintenance. Both provisions require the borrowers to make a lump sum payment in addition to the outstanding loan balance to compensate the lender for potential losses from reinvesting prepayment proceeds in a lower-yield environment. City Capital Realty Shawn Rabban 310-714-5616 shawnrabban@yahoo.com CAL BRE. 00667328 NMLS. 298861 / 729817 "California Bureau of Real Estate, Real Estate Broker 16