FIN 324: CH16 Commercial Mortgage Types and Decisions

One of the main differences between residential mortgage loans and permanent financing of commercial real estate lies in the allocation of liability in the case of default. In commercial real estate, a “bankruptcy remote” special-purpose entity is created that shields the actual borrower from personal liability. When a lender cannot lay claim to the personal assets of the defaulted borrower, this type of loan is commonly referred to as a:

Group of answer choices

nonrecourse loan.

mini-perm loan.

partially amortizing loan.

interest-only loan.

nonrecourse loan.

In recent years, lenders have been unwilling to relieve borrowers from personal liability in the event of fraud, environmental problems, or unpaid property tax obligations. Therefore, some lenders include a clause that pierces the single-purpose borrowing entity to hold the actual borrower liable in such instances. This clause is commonly referred to as a:

Group of answer choices

habendum clause.

lockout provision.

defeasance.

“bad boy carve-out” clause.

“bad boy carve-out” clause.

Which of the following types of loans is the most common instrument used to finance the acquisition of existing commercial property?

Group of answer choices

fixed-rate balloon mortgage loans

floating-rate mortgage loans

mezzanine loans

construction loans

fixed-rate balloon mortgage loans

Some commercial mortgages have adjustable, or floating, interest rates. The index rate to which the contract rate is tied is typically which of the following for commercial mortgages?

Group of answer choices

the yield on a constant maturity Treasury security of the same term

the cost of funds index (COFI)

the London Interbank Offer Rate (LIBOR)

the interest rate on a comparable maturity level-payment mortgage

the London Interbank Offer Rate (LIBOR)

While balloon mortgage loan payments are typically based on a 30-year amortization schedule, the loan actually matures in either 3, 5, 7, or 10 years. Of the following, which is the primary risk that a lender reduces their exposure to through the relatively short loan term on a balloon mortgage?

Group of answer choices

default risk

interest rate risk

liquidity risk

financial risk

interest rate risk

In contrast to residential mortgage loans, most fixed-rate commercial mortgages do not allow borrowers to freely prepay the principal on their loan. Which of the following prepayment penalties ties the penalty that borrowers pay to how far interest rates have declined since origination?

Group of answer choices

lockout provisions

yield-maintenance agreements

defeasance

curtailment

yield-maintenance agreements

If mortgage rates decline significantly, borrowers may decide to prepay the principal on their loan even if they face prepayment penalties. One way that lenders protect themselves from prepayments in such circumstances is by requiring the borrower who prepays to purchase for the lender a set of U.S. Treasury securities whose coupon payments replicate the cash flows the lender will lose as a result of the early retirement of the mortgage. This process is referred to as:

Group of answer choices

lockout.

yield-maintenance.

defeasance.

curtailment.

defeasance.

While floating rate mortgage loans may offer lower interest rates to borrowers than comparable fixed-payment mortgages, floating-rate loans may increase a lender’s exposure to which of the following risks since borrowers may not be able to continue to service the debt if payments on the loan increase significantly?

Group of answer choices

default risk

interest rate risk

liquidity risk

pipeline risk

default risk

The yields on commercial mortgages have been approximately 2 percent higher, on average, than the yields on comparable maturity treasury securities over the past 20 years. Often considered the signature risk of commercial mortgage lending, this spread primarily represents:

Group of answer choices

default risk.

interest rate risk.

pipeline risk.

fallout risk.

default risk.

There are a number of alternatives when it comes to the capital structure for acquisitions of commercial real estate. Through which of the following lending relationships does the lender have the right to foreclose on the equity of the borrower’s company in the case of default?

Group of answer choices

second mortgage loan

mezzanine loan

mini-perm loan

construction loan

mezzanine loan

An interest-only balloon mortgage loan is commonly referred to as a(n):

Group of answer choices

miniperm loan

mezzanine loan

land acquisition loan

bullet loan

bullet loan

In order to better understand a borrower’s probability of default, lenders have a number of tools at their disposal. The ratio that measures the percentage of the price (or value) of a property that is encumbered by the first mortgage is referred to as the:

Group of answer choices

debt coverage ratio (DCR).

loan-to-value ratio (LTV).

break-even ratio (BER).

price-earnings ratio (PE).

loan-to-value ratio (LTV).

Which of the following ratios measures the extent to which a property’s net operating income (NOI) can decline from expectations before it is insufficient to service the mortgage debt?

Group of answer choices

debt coverage ratio (DCR)

loan-to-value ratio (LTV)

break-even ratio (BER)

debt-yield ratio

debt coverage ratio (DCR)

The use of financial leverage by real estate investors can be a double-edged sword. All of the following statements regarding the use of financial leverage by real estate investors are true EXCEPT:

Group of answer choices

The use of financial leverage by real estate investors mitigates the impact that limited financial resources would otherwise have on their pursuit of investment opportunities.

The use of financial leverage by real estate investors will increase the internal rate of return (IRR) on equity as long as the cost of borrowing is less than the unlevered IRR.

The use of financial leverage reduces the real estate investor’s exposure to default risk.

The use of financial leverage by real estate investors makes the realized return on equity more sensitive to changes in rental rates and resale values.

The use of financial leverage reduces the real estate investor’s exposure to default risk.

Although nonrecourse loans dominate the commercial mortgage lending practices of pension funds, life insurance companies, and commercial mortgage-backed security (CMBS) originators, banks are likely to require some form of a guarantee by the organizer/sponsor of the investment opportunity to make the lender whole in the event the lender suffers a loss on the loan. This protection to the lender is more commonly referred to as a:

Group of answer choices

credit enhancement.

property externality.

joint venture.

mezzanine loan.

credit enhancement.

Relative to residential loans, the underwriting process for commercial loans is more complicated. The commercial loan underwriting process focuses first on which of the following?

Group of answer choices

individual borrower’s credit quality

income producing potential of the collateral property

individual borrower’s wages

individual borrower’s personal assets

income producing potential of the collateral property

Prospective borrowers often submit loan requests directly to lenders. However, commercial loan requests can also be submitted through another channel in which a permanent lender agrees to purchase loans or consider loan requests from a mortgage banker or broker. This type of business relationship is more commonly referred to as a(n):

Group of answer choices

installment sale.

joint venture.

correspondent relationship.

sale-leaseback.

correspondent relationship.

Once a loan application is signed, the lender begins a process that typically includes ordering the fee appraisal, the title report, and a number of third party inspection, compliance, and engineering reports in an attempt to make sure the potential borrower did not misrepresent the property in any way in the original loan submission package. This process is more commonly referred to as:

Group of answer choices

due diligence.

loan submission.

loan development.

defeasance.

due diligence.

Which of the following terms refers to a written agreement that binds the lender to make a loan to the borrower provided the borrower satisfies the terms and conditions of the agreement?

Group of answer choices

loan application

loan commitment

loan underwriting

loan document

loan commitment

Different financing requirements usually are involved in the various phases of a property’s life. Which of the following types of loans is used to finance improvements to the land, such as sewers, streets and utilities?

Group of answer choices

land acquisition loans

land development loans

construction loans

bridge loans

land development loans

Land acquisition, development, and construction loans used by developers differ significantly from the “permanent” mortgages that traditionally are used to finance the purchase of commercial properties. All of the statements listed below are true regarding land acquisition, development, and construction loans EXCEPT:

Group of answer choices

developers can never be held personally liable for such loans.

these loans have floating interest rates tied to short-term interest rate indices.

these loans are interest-only loans.

these loans can be prepaid at any time without penalty.

developers can never be held personally liable for such loans.

If the mortgage loan is going to be packaged with similar loans and then resold to investors as part of a commercial mortgage-backed security, the originating lender may rely more heavily on examining which of the following ratios in order to determine the maximum amount they are willing to lend to the borrower? (Note: This ratio indicates the cash-on-cash return the lender would earn on its invested capital if it had to foreclose on the property immediately after originating the loan.)

Group of answer choices

debt coverage ratio

debt yield ratio

debt service ratio

equity dividend ratio

debt yield ratio

The risk that a property’s net operating income (NOI) will be less than its debt service is often referred to as:

Group of answer choices

financial risk.

interest rate risk.

reinvestment risk.

prepayment risk.

 

financial risk.

A commercial real estate loan may take 90 days from the signing of the purchase and sale contract until loan closing. Therefore, there is the possibility for interest rates to fluctuate during this period. In some cases, the lender may offer the borrower the opportunity to “lock in” the interest rate on the loan. To protect against exposure to rate increases during this period, the borrower is often willing to pay a nonrefundable fee as part of what is more commonly known as a:

Group of answer choices

lockout provision.

rate lock agreement.

floating rate agreement.

yield maintenance provision.

rate lock agreement.

The use of a mezzanine loan in the purchase of a commercial property has all of the following impacts on the borrower EXCEPT:

Group of answer choices

allows the borrower to increase their financial leverage in the purchase of the property.

increases the borrower’s expected first year return on equity.

mitigates the risk of financing for the borrower.

requires the borrower to pledge an equity interest in their company (e.g., LLC) as collateral for the loan rather than pledging the property.

mitigates the risk of financing for the borrower.

The note is the document used to create a legal debt. In most states, the note creates personal liability for residential borrowers. When mortgage lenders have access to other borrower assets in situations where the foreclosure sale price is less than the total amount of the loan outstanding, we commonly refer to this type of loan as a:

Group of answer choices

nonrecourse loan.

miniperm loan.

partially amortizing loan.

recourse loan.

recourse loan.

The flexibility to prepay the principal on a mortgage loan differs significantly between commercial and residential mortgages. Which of the following clauses prohibits prepayment of the mortgage loan for a specified period of time after its origination?

Group of answer choices

lockout provisions

yield maintenance agreements

defeasance

curtailment

lockout provisions

Based on your understanding of the concept of a lockout provision, lenders are able to reduce their exposure to which of the following risks through its use?

Group of answer choices

default risk

reinvestment risk

liquidity risk

interest rate risk

reinvestment risk

Commercial banks most commonly provide floating rate loans. However, borrowers who prefer a fixed rate can obtain an agreement that exchanges floating rate payments for a fixed rate schedule. This type of agreement is more commonly referred to as a(n):

Group of answer choices

curtailment.

defeasance.

foreclosure.

interest rate swap.

interest rate swap.

When a lender receives a specified portion of a property’s net operating income and/or net sale proceeds as part of the loan agreement, this loan type is more commonly referred to as a:

Group of answer choices

miniperm loan.

mezzanine loan.

participation loan.

bullet loan.

participation loan.

Some investors obtain more than one loan when acquiring properties, thereby substituting more debt financing for equity financing. A traditional second mortgage is secured by:

Group of answer choices

an equity interest in their company (e.g., LLC).

the borrower’s pledge of the property as collateral.

a set of US Treasury securities whose coupon payments replace the mortgage cash flows.

a balloon payment made by a government sponsored enterprise.

the borrower’s pledge of the property as collateral.

Construction loans are used to finance the costs associated with erecting the building or buildings on a site. All of the following would be typical of a construction loan EXCEPT:

Group of answer choices

LTV ratios above 90 percent.

preleases with anchor tenants.

relatively short maturity length of one to three years that may also allow for time to construct and lease up the project.

personal liability.

LTV ratios above 90 percent.

Developers may obtain a single, short-term mortgage loan from an interim lender that provides financing for the construction period, the lease-up period, and for several years beyond the lease-up stage. This loan type is more commonly referred to as a:

Group of answer choices

miniperm loan.

mezzanine loan.

participation loan.

bullet loan.

miniperm loan.

Which of the following loan types is used to finance the costs associated with erecting the building (i.e., “going vertical”)?

Group of answer choices

land acquisition loan

land development loan

construction loan

miniperm loan

 

land acquisition loan

Which of the following types of loans are often used to provide short-term financing for “transitional” properties (e.g., properties that are currently experiencing heightened vacancies, or that need to be redeveloped or renovated before they can be stabilized)?

Group of answer choices

land acquisition loan

land development loan

construction loan

bridge loan

bridge loan

Given the following information, calculate the debt coverage ratio of this commercial loan.

Estimated net operating income (NOI) in the first year: $150,000

Debt service in the first year: $100,000

Loan amount: $1,000,000

Purchase price: $1,300,000

Group of answer choices

0.15

0.67

1.30

1.50

1.50

Given the following information, calculate the loan-to-value ratio of this commercial loan.

Estimated net operating income in the first year: $150,000

Debt service in the first year: $100,000

Loan amount: $1,000,000

Purchase price: $1,300,000

Group of answer choices

0.08

0.77

1.30

1.75

0.77

Given the following information, calculate the debt yield ratio on the following commercial property.

Estimated Net Operating Income in the first year: $2,500,000

Debt service in the first year: $960,000

Loan amount: $20,000,000

Purchase price: $27,300,000

Group of answer choices

4.8%

12.5%

68.6%

75.2%

12.5%

Suppose you are considering the purchase of an apartment building that has 12 units that can be rented out at $1,050 per month. You have estimated operating expenses and expected vacancy and collection losses for the first year to be $35,700 and $30,240, respectively. You also have estimated that you will be able to generate an additional $3,840 in the first year from garage rentals on the property. If the expected purchase price of the property is $1,100,000 and you are planning on making a 10% down payment, calculate the debt yield ratio.

Group of answer choices

8.10%

8.61%

9.00%

12.05%

9.00%

Assume you have taken out a balloon mortgage loan for $2,500,000 to finance the purchase of a commercial property. The loan has a term of 5 years, but amortizes over 25 years. Calculate the balloon payment at maturity (Year 5) if the interest rate on this loan is 4.5%.

Group of answer choices

$5,637.99

$13,895.82

$2,196,447.59

$2,495,479.19

$2,196,447.59