Teach me something about commercial lending

[Loc R.]

After calling a few commercial mortgage brokers, I've realized that the game changes after 5+ units.

My experience has been with 2-4 units. Lending on it is pretty easy/straightforward. You want a 30-year fixed loan? You got it.

You want a loan on 5+ units? Everything is 5/5/30 (30 years amortized, 1st 5 years are fixed, 5 years variable, balloon at 10) or something of that configuration. Is the thinking that the borrower won't be in that building long enough? Or that the lender doesn't want to commit to today's rate for 30 years b/c a spike in rates now makes his loan worth less? Or that a jump in the variable rate gets passed on to the tenants anyways?

Give me the primer on commercial lending.

[Darryl Dahlen]

It really boils down to lender risk and how they can mitigate it.

There are so many moving parts to commercial loans (property value, property maintenance, changing market conditions, occupancy issues, rent, etc.) that lenders "usually" want to re-evaluate a property every so often.

By issuing notes that balloon in 1-5 years, lenders can re-underwrite a file to either refinance the property or call the note and make the borrower go elsewhere.

There is also a smaller issue that lenders like to diversify their portfolios. What is good today, may not be good down the road.

For example, hotels are now considered a bad bet and are very hard to finance due to falling values and high vacancies, but 5 years ago, they were in much better shape.

So, most lenders are trying to get most hotel loans off of their books. If lenders issued 10-30 year notes, they would be swimming in toxic paper. Well, more toxic paper.

Make sense?

NOTE: As Bryan eluded to, there are long term loans out there, but those are almost always loans that have a government guarantee (SBA, HUD, Fannie/Freddie, and USDA). That guarantee makes it possible for the lender to put their money out there for 20-40 years.

Some REITs, Insurance companies, and pension funds will also do long term loans, but those loans are for very experienced borrowers that usually have a portfolio of performing properties.