Overview
A commercial mortgage is similar to a residential mortgage, except the
collateral is a commercial building or other business real estate, not
residential property.
In addition, commercial mortgages are typically taken on by businesses
instead of individual borrowers. The borrower may be a partnership,
incorporated business, or limited company, so assessment of the
creditworthiness of the business can be more complicated than is the case
with residential mortgages.
Commercial mortgages are typically nonrecourse, that is, that in the event
of default in repayment, the creditor can only seize the collateral, but has
no further claim against the borrower for any remaining deficiency. Less
commonly, the mortgage is supplemented by a general obligation of the
borrower, which makes the debt payable in full even if foreclosure on the
mortgaged collateral does not satisfy the outstanding balance.
Commercial Mortgage loans are almost always designed to be underwritten
based on entirely on the attributes of the property being mortgaged, as
opposed to the credit attributes of the borrower. To facilitate this, many
times lenders require the property to be owned by a single asset entity such
as a corporation or an LLC created specifically to own just the subject
property. This allows the lender to foreclose on the property in the event
of default even if the borrower went into bankruptcy (the entity is known as
"bankruptcy remote"). In a normal residential mortgage, a lender would have
a difficult time selling a property if the bankruptcy court case is still
pending.
Lenders usually also require a minimum debt service coverage ratio which
typically ranges from 1.1 to 1.4; the ratio is net cash flow (the income the
property produces) over the debt service (mortgage payment). As an example
if the owner of a shopping mall receives $300,000 per month from tenants,
pays $50,000 per month in expenses, a lender will typically not give a loan
that that requires monthly payments above $227,273
(($300,000-$50,000)/1.1)), a 1.1 debt cover.
Lenders also look at Loan to value (LTV). LTV is a mathematical calculation
which expresses the amount of a mortgage as a percentage of the total
appraised value. For instance, if a borrower wants $6,000,000 to purchase an
office worth $10,000,000, the LTV ratio is $6,000,000/$10,000,000 or 60%.
Commercial mortgage LTV's are typically between 55% and 70%, unlike
residential mortgages which are typically 80% or above.