Real Estate Fundamentals
Course Objectives
Identify differences and
similarities between commercial
real estate loan types
Interpret key underwriting
parameters for commercial real
estate lending
Compare equity lending and
cash flow lending
Analyze multiple commercial
real estate borrowing scenarios
Calculate lending ratios and
appropriate loan amounts
Explain the timeline and end-toend process of a commercial real
estate transaction
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Terms & Definitions
Loan to
Value (LTV)
Net Operating
Income (NOI)
Capitalization
Rate
(Cap Rate)
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What the loan amount will be, expressed as a percentage of the total
asset value. LTV may represent the loan amount relative to the purchase
price, the appraised value, or to some other calculated asset value.
Gross rental income less operating expenses; used to compare profitability
of rental properties.
NOI
Market Value of the Property
Expressed as a percentage (e.g., 4.5%)
Terms & Definitions
Amortization
Period
Term
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The number of months or years over which the principal repayments of
a loan are spread; the total length of time it will take to pay off the mortgage.
The length of time that the interest rate is agreed to.
Commercial Real Estate
Real Estate Definition
Real
Property
Estate
Derived from “realty” – refers to the land and immovable items permanently
affixed to that land, like buildings.
Property that is not land or permanent land fixtures is considered personal
property (e.g., vehicles, stocks, bonds, patents).
Represents “all things which are owned by a person.”
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Real Estate Definition
Real
Property
Estate
Commercial real estate is real property
owned for the purpose of conducting some
commercial activity.
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Real Estate Definition
Real estate is a market. The market is made at the point of equilibrium between the supply and demand
for space.
Real Estate
Equity
Asset Classes
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Fixed Income
Real Estate Definition
Real estate is a market. The market is made at the point of equilibrium between the supply and demand
for space.
Real Estate
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Mutual Funds
ETFs
REITs
Properties
Property Types
Property types can be separated into two broad categories − residential and non-residential.
Non-Residential
Residential
Single Family
Personal Lending
Multifamily
Commercial Financing
Retail
Office
Special
Use
Industrial
Land
Commercial Lending Structures
Both considered residential if people
live in them.
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These properties have a clear commercial purpose,
supported by appropriate zoning.
Multifamily Properties
Multifamily properties are residential sites.
Condominium
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Multifamily
Multifamily Properties
Multifamily properties generally fall into two categories – high rise and low rise.
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Amenities
Min. # Units
Many Floors
Fewer Units
Large Towers
Smaller
High Rise
Low Rise
Multifamily Properties
Multifamily structures have unique characteristics that other commercial properties do not.
Advantages of multifamily structures:
• Residential tenancy is less levered to economic cycles –
steady demand during contractions and recessions.
• With government-backed residential mortgage insurance,
multifamily owners can secure loan insurance, which can
sometimes support higher LTV or lower interest rates.
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Multifamily Properties
Multifamily structures have unique characteristics that other commercial properties do not.
Disadvantages of multifamily structures:
• Residential leases only last 12 months, converting to
month-to-month arrangements after the initial term
• Constant turnover with varying tenant start and end dates
• Lack of pricing power due to tenant protections stopping
landlords from raising rents more than a maximum per year
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Retail Properties
Retail properties are commonly known as places where the tenant’s customers enter in order to
conduct a transaction. Goods or services are exchanged for payment on-site in real time.
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Retail Properties
Retail properties are commonly known as places where the tenant’s customers enter in order to
conduct a transaction. Goods or services are exchanged for payment on-site in real time.
Tenants can be independent retailers or multi-site businesses
• Larger tenants are better from the lender’s perspective
• Large chains tend to vet prospective sites and franchisees for
management acumen and financial strength
• Sometimes, national franchisors provide corporate guarantees
on behalf of their tenants
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Retail Properties
Anchor Tenant
Owner and
landlord has
negotiating
leverage
Lender is more
comfortable
extending credit
due to foot traffic
Plaza
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Office Properties
Office properties serve the needs of a variety of white-collar industries.
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Office Properties
Office properties serve the needs of a variety of white-collar industries.
Office Sites
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01
Low customization
02
Includes specialty sites
03
Tend to cluster
Industrial Properties
Industrial properties fall into two categories – heavy industrial or light industrial.
Heavy Industrial
Light Industrial
Large Standalone Sites
Less Customization
Significant Customization
Usually warehouse facilities
clustered in industrial parks
Heavy Manufacturing Features
Usually Single Tenant
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Designed for businesses to have
customers on site for transactions
Industrial Properties
Industrial properties fall into two categories – heavy industrial or light industrial.
If the tenant goes out of business…
Heavy Industrial
Unlikely to find a new tenant that
requires the same specifications
Large Standalone Sites
Significant Customization
Many costly modifications required
Heavy Manufacturing Features
Usually Single Tenant
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Thus, light industrial properties are more
desirable as collateral.
Special Use Properties
The special use classification serves as a broad umbrella for an array of property types that don’t fit
into another category.
Golf Course
Hotel
Hospital
Student
Housing
Each of these has a very specific use that would require considerable customization.
The risk for a lender that finances a special use property is that it is hard to get a new tenant into the
facility in the case of defaults without significant modifications.
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Special Use Properties
The special use classification serves as a broad umbrella for an array of property types that don’t fit
into another category.
Restaurants
Bars
Night Clubs
These are considered special use because of structural customization but also because they are closely
linked to economic cycles.
• When business is bad for one restaurant or bar, it is bad for all of them
• When a tenant is most needed, that is when there are none
From a lending perspective, special use properties usually have lower loan-to-values (LTV) and shorter
amortizations.
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Bare Land
Bare land does not usually have a tenant or generate cash flow.
Serviced Land
Access to the power grid, water, and sewer
systems
Land loan
requests are usually
made alongside
construction project
financing
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Unserviced Land
No access to the power grid, water, and
sewer systems
Commercial Real Estate Structure
Reasons to Own Commercial Real Estate
Most businesses require a physical location to operate. Some make the strategic decision to own their
facility. A variety of factors go into the decision of whether to rent or own.
Location
Proximity to
Customers
Proximity to
Workforce
Market Rents
vs. Property
Prices
Facility Size
Customization
If a business owns the facility in which it operates, it is called owner-occupied commercial
real estate.
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Reasons to Own Commercial Real Estate – Owner-Occupied Example
John Johnson owns an accounting firm that has been at the same location for 6 years. His landlord
approaches him saying he is looking to sell the building.
• 20 employees; no plans for growth
John should buy the building.
• Most staff within 15-minute commute
• Has capital to use as a down
payment
• Most customers local; enjoy on-site parking
• Monthly loan payment & occupancy costs would
be the same as the current rent
Should John buy this building?
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• Location is good
• Costs would be about the same
• His firm would have location
security for the rest of its existence
Reasons to Own Commercial Real Estate – Investment Example
Dave Davidson just sold his business and is retired. He has a lump of cash that he is looking to put into
something that will generate monthly income.
• Dave does not like the stock market or wild price
swings.
• Bond yields are low; borrowing costs are low.
• There is a light industrial warehouse in an adjacent
community with a reasonable valuation
• The tenant – a reputable local company – just
re-signed a 10-year lease
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Should Dave buy this
building?
Dave should at least entertain
conducting more due diligence
around the property.
Reasons to Own Commercial Real Estate – Investment
This is an example of a second kind of commercial real estate owner – the investor.
Investors, like Dave, want access to the monthly cash flow
dictated in the terms of the lease.
• Stable and predictable cash flows
• Cash principal will not fluctuate daily like a stock portfolio
• Value is protected by the underlying asset (building)
Investors can be individuals as well as institutional investors.
REIT
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Life Insurance
Companies
Pension
Funds
Reasons to Own Commercial Real Estate – Summary
There are many reasons why investors seek to own real estate.
1
Great store of
value that does
not fluctuate daily
4
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2
Good protection
against inflation
Allows businesses
to reallocate rent
costs into equity
5
3
Allows access to
high levels of
leverage
Generates cash
flow
Commercial Real Estate Structure
The underwriting and analysis parameters for owner-occupied and income-producing properties vary, but
there are several similarities when analyzing creditworthiness for real estate lending.
Value
Appraisal
For property acquisitions, this is the agreed
upon purchase price.
Real estate lending transactions will always
be accompanied by an appraisal.
Can also be determined using valuation
methods.
Prepared by an independent, verified, and
accredited third party.
There may be strategic reasons to pay more
than the appraised value.
Expressly stipulated as having been prepared
for the purposes of financing.
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Commercial Real Estate Structure
The underwriting and analysis parameters for owner-occupied and income-producing properties vary, but
there are several similarities when analyzing creditworthiness for real estate lending.
Collateral Mortgage
Environmental Analysis
Lender will register to cover the full amount
of loan exposure.
Conducted by an independent and approved
third party.
Borrower is pledging the property and
building as collateral for the loan.
Looks at the historical property uses, and red
flags determine the level of due diligence
required.
Loans backstopped by real estate have the
most favorable terms.
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Commercial Real Estate Structure
The underwriting and analysis parameters for owner-occupied and income-producing properties vary, but
there are several similarities when analyzing creditworthiness for real estate lending.
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Purchase & Sale Agreement
A purchase and sale agreement is an important part of the loan due diligence process that details
the terms of the transaction.
Initiates the transaction and
defines the property using
both civic and legal
addresses
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Purchase & Sale Agreement
A purchase and sale agreement is an important part of the loan due diligence process that details
the terms of the transaction.
Serves as a roadmap for the
transaction and anticipated
timeline
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Purchase & Sale Agreement
A purchase and sale agreement is an important part of the loan due diligence process that details
the terms of the transaction.
Legally specifies each
stakeholders’ obligations
and rights
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Purchase & Sale Agreement
A purchase and sale agreement is an important part of the loan due diligence process that details
the terms of the transaction.
Conditions that the deal
must follow – “subject to”
conditions (clauses or
provisions)
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Purchase & Sale Agreement
A purchase and sale agreement is an important part of the loan due diligence process that details
the terms of the transaction.
Agreed upon purchase price
and any deposits that are
outlined
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Purchase & Sale Agreement
The first draft of the agreement is prepared by the seller’s legal counsel, then sent to the buyer for
review. Negotiations continue until parties can agree on each point or provision – such as:
1
Description of the
property & any
improvements that
will remain affixed
4
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2
Inspections,
survey results,
and title review
Assignments –
leases and contract
rights specific to the
property
5
3
Broker
Involvement
Adjustments to the
purchase price
at closing
Types of Commercial Real Estate Loans
There are four types of commercial real estate loans, each with unique characteristics.
Owner-Occupied
Commercial Mortgage
Loan to finance a commercial property
where the owner uses it to run their
business.
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Income-Producing
Commercial Mortgage
Loan to finance or refinance properties
with tenants that are arms’ length from
the property owner. Cash flow is rent.
Types of Commercial Real Estate Loans
There are four types of commercial real estate loans, each with unique characteristics.
Construction Loan
Loan for the purpose of financing the
construction of a building.
Frequently advanced in segments
(“draws”).
Typically interest only.
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Types of Commercial Real Estate Loans
There are four types of commercial real estate loans, each with unique characteristics.
Construction Loan
End purpose is known and can
determine the terms and structure of
the loan.
Repayment happens at one time,
called a “take-out.”
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Bridge Loan
Considered higher risk and is
compensated with higher rates and
fees. In some instances, lenders may
seek an equity stake.
These loans are temporary in nature
and are used when traditional
financing is not available.
Site Visit
Regardless of the type of loan, an integral component of any lender’s due diligence process is the site visit.
A real estate loan should not be considered without seeing and inspecting the physical site.
Third-Party Experts
Credit Analyst
Commercial Appraisers
Physical Site Visit
Environmental Consultants
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Site Visit
Site Confirmation
Site Risk Screening
Activity Inspection
Does the location exist?
Understand issues that may
reduce the collateral value
Is the company conducting
business safely & ethically?
Environmental Concerns
Waste, discharge, etc.
Will anything prevent the
business from continuing as
a going-concern?
Do the addresses match
documentation?
Does the site look as
described?
Are there active operations?
Are there actual tenants?
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Building-Specific Risks
Deferred maintenance,
Exposed wires, fall hazards,
building access, etc.
Are tenant’s occupying the
site safely? Is there anything
illegal going on?
Site Visit
Ensure your own safety when on site.
Wear personal protective equipment like a helmet, proper footwear, masks,
googles, or anything else that will protect you.
Ask questions, probe deeper if something does not seem right. Ask questions
directly of the property owner or manager, even of third-party providers.
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Commercial Real Estate Analysis
Analyzing an Owner-Occupied Transaction
When a company is going to run their own business on the site or in the building, lenders need to
underwrite the property loan to the strength of the operating company itself.
Debt Service
EBITDA + Rent
Annual Interest + Principal Obligations
1
2
3
4
Appraisal
Environmental
Report
Registered
Mortgage
Lending
Policies and
Requirements
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Analyzing an Income-Producing Transaction
When analyzing a lending opportunity for an income-producing investment property, the financials are
for property-specific rental income and expenses.
Lease Terms
Rental Income
Reporting requirements include copies of the leases and rent roll in the diligence package.
Expenses can vary between each property owner. It is important for lenders to make appropriate
adjustments to understand what normalized cash flows look like on an annual basis.
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Underwriting Parameters – Environmental Considerations
Environmental considerations around a property are paramount. If contaminants from a previous
occupant go undetected at purchase but are later discovered, several issues may arise.
!
Tenants may legally
cease operations,
drying up cash flow
to service the
mortgage.
!
Tenants may bring
litigation against the
property owner
and/or the lender.
If the property owner (borrower) defaults, the lender would be left with a site that cannot be sold
without considerable and costly cleanup.
Environmental issues are typically binary. If they exist, most financial institutions won’t do the deal.
Some higher risk private lenders may still finance the transaction using a bridge facility, with
terms that encourage the immediate remediation and refinance under less restrictive terms.
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Underwriting Parameters – Environmental Considerations
Category
Environmental
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Criteria/Relevance
Legal enforceability of collateral; future
salability of the property
Influence on Transaction
Deal or no deal
Underwriting Parameters – Property Type
The type of property can have a material impact on a real estate transaction.
Office & Light Industrial
Special Use
Easy to market & secure tenants
Limited tenant base due to
customization
Mitigates some risk, higher LTV, and
longer amortizations
Downward adjustment to LTV or
amortization period
Bare land has the strictest terms and structures. It does not generate cash flow so debt servicing
must come from other sources. Bare land is usually included as part of a broader transaction request.
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Underwriting Parameters – Property Type
Category
Criteria/Relevance
Influence on Transaction
Environmental
Legal enforceability of collateral; future salability
of the property
Deal or no deal
Property Type
Ability to substitute tenants; degree of
customization
Adjustment to maximum LTV or
amortization period
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Underwriting Parameters – Tenant Quality
The borrower’s tenants are the source of cash flow for loan repayment. Thus, financial institutions
prefer good, reputable tenants.
Anchor
Tenant
Franchise
Guarantee
Size and Stability
of Firm
Lenders make an upward adjustment to the interest term for a government-tenanted office site.
Conversely, they may make an upward adjustment in vacancy allowance for smaller businesses. This
leads to downward adjustments to loan amounts or LTVs.
In some cases, a specific tenant can be enough for a lender to walk away from the transaction
altogether.
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Underwriting Parameters – Tenant Quality
Category
Criteria/Relevance
Influence on Transaction
Environmental
Legal enforceability of collateral; future salability
of the property
Deal or no deal
Property Type
Ability to substitute tenants; degree of
customization
Adjustment to maximum LTV or
amortization period
Tenant Quality
Anchor tenant? Franchise guarantee? Size
and stability of the firm?
Adjustment to interest term. Deal or
no deal. Vacancy adjustments +/-
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Underwriting Parameters – Lease Maturity
The lease maturity profile is the average duration of current leases across all units within the
property being financed.
Tenant leases expiring in (months)
01.
12
12
12
12
12
Higher Risk
02.
12
24
36
48
60
Lower Risk
In the first example, a lender would not likely extend an interest term beyond 12 months.
However, in the second example….
12 + 24 + 36 + 48 + 60
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= 36-Month Interest Term
Underwriting Parameters – Lease Maturity
Category
Criteria/Relevance
Influence on Transaction
Environmental
Legal enforceability of collateral; future salability
of the property
Deal or no deal
Property Type
Ability to substitute tenants; degree of
customization
Adjustment to maximum LTV or
amortization period
Tenant Quality
Anchor tenant? Franchise guarantee? Size and
stability of the firm?
Adjustment to interest term. Deal or no
deal. Vacancy adjustments +/-
Lease Maturity
Expiry of current leases; anticipated
turnover. Are expiries staggered?
Adjustment to interest term
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Underwriting Parameters – Building Condition
The condition of the building is a factor in a lending decision.
The age of the building is outlined in the appraisal. Sometimes, lenders have
policies that require additional due diligence on buildings that are older.
A key metric in lending decisions is the estimated useful economic life of the structure.
A much older building may also require lenders to set aside a larger repairs and maintenance reserve
when calculating normalized net operating income.
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Underwriting Parameters – Building Condition
Category
Criteria/Relevance
Influence on Transaction
Environmental
Legal enforceability of collateral; future salability
of the property
Deal or no deal
Property Type
Ability to substitute tenants; degree of
customization
Adjustment to maximum LTV or
amortization period
Tenant Quality
Anchor tenant? Franchise guarantee? Size and
stability of the firm?
Adjustment to interest term. Deal or no
deal. Vacancy adjustments +/-
Lease Maturity
Expiry of current leases; anticipated turnover.
Are expiries staggered?
Adjustment to interest term
Building Condition
Will the building require significant updating?
Useful economic life?
Adjustment to maximum LTV or
amortization period
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Underwriting Parameters – Location
Location can play a large role in determining a sensible loan amount.
Urban centers have more people,
businesses, and prospective tenants.
Higher premiums are due to closer
proximity to businesses and transit.
Class A
Highly desirable,
prime locations,
and built
recently
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Class B
Older buildings
requiring updates
and areas with
zoning changes
In rural areas, if a unit becomes
unexpectedly vacant, it is often
harder to find a tenant. This
disrupts cash flows.
Class C
Need significant
work and are far
from the central
business district
Adj. for rural/non-prime areas:
Vacancy Allowances….
Min. Debt Service Req.….
Loan to Value (LTV)…
Underwriting Parameters – Location
Category
Criteria/Relevance
Influence on Transaction
Environmental
Legal enforceability of collateral; future salability
of the property
Deal or no deal
Property Type
Ability to substitute tenants; degree of
customization
Adjustment to maximum LTV or
amortization period
Tenant Quality
Anchor tenant? Franchise guarantee? Size and
stability of the firm?
Adjustment to interest term. Deal or no
deal. Vacancy adjustments +/-
Lease Maturity
Expiry of current leases; anticipated turnover.
Are expiries staggered?
Adjustment to interest term
Building Condition
Will the building require significant updating?
Useful economic life?
Adjustment to maximum LTV or
amortization period
Location
Urban vs. rural. “A”, “B”, or “C” class property? Adjustment to minimum DSC, LTV, or
vacancy allowance
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Underwriting Parameters – Cash Flow
Bare land does not produce cash flow, so it is higher risk from a lender’s perspective.
There are often more restrictive structures on properties with no cash flows or uncertain cash flows.
Shorter
Amortization
Shorter Interest
Terms
Smaller Maximum
LTV
Proposed structures also depend on whether the lender is a cash flow lender or an equity lender.
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Underwriting Parameters – Cash Flow
Category
Criteria/Relevance
Influence on Transaction
Environmental
Legal enforceability of collateral; future salability
of the property
Deal or no deal
Property Type
Ability to substitute tenants; degree of
customization
Adjustment to maximum LTV or
amortization period
Tenant Quality
Anchor tenant? Franchise guarantee? Size and
stability of the firm?
Adjustment to interest term. Deal or no
deal. Vacancy adjustments +/-
Lease Maturity
Expiry of current leases; anticipated turnover.
Are expiries staggered?
Adjustment to interest term
Building Condition
Will the building require significant updating?
Useful economic life?
Adjustment to maximum LTV or
amortization period
Location
Urban vs. rural. “A”, “B”, or “C” class property?
Adjustment to minimum DSC, LTV, or
vacancy allowance
Cash Flow
Is there cash flow? Where will it come from?
Determined by lease terms; limited ability to
increase. Stability?
Adjustment to maximum loan
amount, LTV, or amortization period
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Commercial Real Estate Process
Commercial Real Estate Process & Timeline
Tenants
Building Condition
Cap Rate
Location
Preliminary
Analysis
Bldg. Condition Report
Appraisal
Enviro. Report
Copies of Leases
Due Diligence
Remove “Subjects”
“Subject to” Conditions
Subject Removal
30–45 days
7–10 days
45–90 days
Property
Search
Negotiation
Purchase Price
Due Diligence Period
Timeline to Closing
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Closing
Financing
Approval
Legal Diligence &
Documentation
Legal Counsel
Loan Agreements
Registering Security
Transferring Funds
Loan Advance & Security Registration
Vendor
Wishes to sell
Calls agent
Orders environmental report
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Negotiates
terms
& price
Purchaser
(Borrower)
Requests
commitment
letter &
appraisal
Puts deposit down
Makes “subject to” conditions
Lender
Commissions appraisal
Starts due diligence
Loan Advance & Security Registration
Once satisfied
Vendor
Purchaser
(Borrower)
Remove “subjects”
45 days to close
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Commitment
letter &
financing approval
Lender
Loan Advance & Security Registration
Vendor
Purchaser
(Borrower)
Lender
Loan & security
agreements
Vendor’s
Counsel
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Purchaser’s
Counsel
Lender’s
Counsel
Loan Advance & Security Registration
Vendor
Purchaser
(Borrower)
Lender
Reviews &
executes
Vendor’s
Counsel
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Purchaser’s
Counsel
Loan &
security
documents
Lender’s
Counsel
Loan Advance & Security Registration
Vendor
Purchaser
(Borrower)
Lender
Vendor’s
Counsel
Purchaser’s
Counsel
Lender’s
Counsel
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Loan Advance & Security Registration
Vendor
Vendor’s
Counsel
Discharge
existing
registrations
Purchaser
(Borrower)
Lender
Purchaser’s
Counsel
Lender’s
Counsel
Register mortgage
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Loan Advance & Security Registration
Vendor
Purchaser
(Borrower)
Lender
Vendor’s
Counsel
Purchaser’s
Counsel
Lender’s
Counsel
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Loan Advance & Security Registration
Vendor
Purchaser
(Borrower)
Lender
Vendor’s
Counsel
Purchaser’s
Counsel
Lender’s
Counsel
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Conclusion
Conclusion
Looked at the differences and
similarities between commercial
real estate loan types
Explored the end-to-end process
of a commercial real estate
transaction and the timeline to
completion
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Examined underwriting
criteria for different
commercial mortgages
Compared equity lending and
cash flow lending and analyzed
borrowing scenarios