Real Estate Fundamentals Course Presentation

Real Estate Fundamentals
Course Objectives
Identify differences and Interpret key underwriting Compare equity lending and
similarities between commercial parameters for commercial real cash flow lending
real estate loan types estate lending
Analyze multiple commercial Calculate lending ratios and Explain the timeline and end-to-
real estate borrowing scenarios appropriate loan amounts end process of a commercial real
estate transaction
Corporate Finance Institute®

Terms & Definitions
What the loan amount will be, expressed as a percentage of the total
Loan to
asset value. LTV may represent the loan amount relative to the purchase
Value (LTV)
price, the appraised value, or to some other calculated asset value.
Net Operating Gross rental income less operating expenses; used to compare profitability
Income (NOI) of rental properties.
Capitalization
NOI
Rate Expressed as a percentage (e.g., 4.5%)
Market Value of the Property
(Cap Rate)

Terms & Definitions
Amortization The number of months or years over which the principal repayments of
Period a loan are spread; the total length of time it will take to pay off the mortgage.
Term The length of time that the interest rate is agreed to.

Commercial Real Estate
Real Estate Definition
Real Derived from “realty” – refers to the land and immovable items permanently
affixed to that land, like buildings.
Property Property that is not land or permanent land fixtures is considered personal
property (e.g., vehicles, stocks, bonds, patents).
Estate Represents “all things which are owned by a person.”

Real
Property
Commercial real estate is real property
owned for the purpose of conducting some
commercial activity.
Estate
Real estate is a market. The market is made at the point of equilibrium between the supply and demand
for space.
Real Estate Equity Fixed Income
Asset Classes

Real estate is a market. The market is made at the point of equilibrium between the supply and demand
for space.
Mutual Funds ETFs
Real Estate REITs Properties

Property Types
Property types can be separated into two broad categories − residential and non-residential.
Residential Non-Residential
Single Family
Retail Office Industrial
Personal Lending
Special
Land
Multifamily Use
Commercial Financing
Commercial Lending Structures
Both considered residential if people These properties have a clear commercial purpose,
live in them. supported by appropriate zoning.

Multifamily Properties
Multifamily properties are residential sites.
Condominium Multifamily

Multifamily properties generally fall into two categories – high rise and low rise.
Amenities Min. # Units
Many Floors Fewer Units
Large Towers Smaller
High Rise Low Rise

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.

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

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.

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

Retail Properties
Anchor Tenant
Owner and Lender is more

landlord has comfortable
negotiating extending credit
leverage due to foot traffic
Plaza

Office Properties
Office properties serve the needs of a variety of white-collar industries.

Office Properties
Office properties serve the needs of a variety of white-collar industries.
01 Low customization
02 Includes specialty sites
03 Tend to cluster
Office Sites

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
Designed for businesses to have
Usually Single Tenant 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…
Unlikely to find a new tenant that

requires the same specifications
Heavy Industrial
Large Standalone Sites
Significant Customization Many costly modifications required
Heavy Manufacturing Features
Usually Single Tenant 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.
Student
Golf Course Hotel Hospital
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.

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.

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 Unserviced Land
construction project
No access to the power grid, water, and
financing
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.
Proximity to Proximity to
Location
Customers Workforce
Market Rents
vs. Property Facility Size Customization
Prices
If a business owns the facility in which it operates, it is called owner-occupied commercial

real estate.

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
• Location is good
• Monthly loan payment & occupancy costs would
be the same as the current rent • Costs would be about the same
• His firm would have location

Should John buy this building? 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 Should Dave buy this
swings. building?
• Bond yields are low; borrowing costs are low.

Dave should at least entertain
• There is a light industrial warehouse in an adjacent conducting more due diligence
community with a reasonable valuation around the property.
• The tenant – a reputable local company – just

re-signed a 10-year lease

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.
Life Insurance Pension

REIT
Companies Funds

Reasons to Own Commercial Real Estate – Summary
There are many reasons why investors seek to own real estate.
1 2 3
Great store of
Good protection Generates cash
value that does
against inflation flow
not fluctuate daily
4 5
Allows businesses Allows access to
to reallocate rent high levels of
costs into equity leverage

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 Real estate lending transactions will always
upon purchase price. be accompanied by an appraisal.
Can also be determined using valuation Prepared by an independent, verified, and

methods. accredited third party.
There may be strategic reasons to pay more Expressly stipulated as having been prepared
than the appraised value. for the purposes of financing.

Collateral Mortgage Environmental Analysis

Lender will register to cover the full amount Conducted by an independent and approved
of loan exposure. third party.
Borrower is pledging the property and Looks at the historical property uses, and red
building as collateral for the loan. flags determine the level of due diligence
required.
Loans backstopped by real estate have the
most favorable terms.


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

Serves as a roadmap for the

transaction and anticipated
timeline

Legally specifies each

stakeholders’ obligations
and rights

Conditions that the deal

must follow – “subject to”
conditions (clauses or
provisions)

Agreed upon purchase price

and any deposits that are
outlined

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:
Description of the Assignments –
1 2 3
Adjustments to the
property & any leases and contract
purchase price
improvements that rights specific to the
at closing
will remain affixed property
4 5
Inspections,
Broker
survey results,
Involvement
and title review

Types of Commercial Real Estate Loans
There are four types of commercial real estate loans, each with unique characteristics.
Owner-Occupied Income-Producing
Commercial Mortgage Commercial Mortgage
Loan to finance a commercial property Loan to finance or refinance properties

where the owner uses it to run their with tenants that are arms’ length from
business. the property owner. Cash flow is rent.

Construction Loan
Loan for the purpose of financing the

construction of a building.
Frequently advanced in segments

(“draws”).
Typically interest only.

Construction Loan Bridge Loan
End purpose is known and can Considered higher risk and is

determine the terms and structure of compensated with higher rates and
the loan. fees. In some instances, lenders may
seek an equity stake.
Repayment happens at one time,
called a “take-out.” 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

Site Visit
Site Confirmation Site Risk Screening Activity Inspection
Does the location exist? Understand issues that may Is the company conducting
reduce the collateral value business safely & ethically?
Do the addresses match
documentation? Environmental Concerns Will anything prevent the
Waste, discharge, etc. business from continuing as
Does the site look as
a going-concern?
described? Building-Specific Risks
Deferred maintenance, Are tenant’s occupying the
Are there active operations?
Exposed wires, fall hazards, site safely? Is there anything
Are there actual tenants? building access, etc. 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.

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
Lending
Environmental Registered
Appraisal Policies and
Report Mortgage
Requirements

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.

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
Tenants may bring
cease operations,
litigation against the
drying up cash flow
property owner
to service the
and/or the lender.
mortgage.
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.

Underwriting Parameters – Environmental Considerations
Category Criteria/Relevance Influence on Transaction

Environmental Legal enforceability of collateral; future Deal or no deal
salability of the property

Underwriting Parameters – Property Type
The type of property can have a material impact on a real estate transaction.
Office & Light Industrial Special Use

Limited tenant base due to
Easy to market & secure tenants
customization
Mitigates some risk, higher LTV, and
Downward adjustment to LTV or
longer amortizations
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.

Underwriting Parameters – Property Type

Environmental Legal enforceability of collateral; future salability Deal or no deal
of the property
Property Type Ability to substitute tenants; degree of Adjustment to maximum LTV or
customization amortization period

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 Franchise Size and Stability

Tenant Guarantee 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.

Underwriting Parameters – Tenant Quality

of the property
Tenant Quality Anchor tenant? Franchise guarantee? Size Adjustment to interest term. Deal or
and stability of the firm? no deal. Vacancy adjustments +/-

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
= 36-Month Interest Term
5

Underwriting Parameters – Lease Maturity

of the property
Tenant Quality Anchor tenant? Franchise guarantee? Size and Adjustment to interest term. Deal or no
stability of the firm? deal. Vacancy adjustments +/-
Lease Maturity Expiry of current leases; anticipated Adjustment to interest term
turnover. Are expiries staggered?

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.

Underwriting Parameters – Building Condition

of the property
Lease Maturity Expiry of current leases; anticipated turnover. Adjustment to interest term
Are expiries staggered?
Building Condition Will the building require significant updating? Adjustment to maximum LTV or
Useful economic life? amortization period

Underwriting Parameters – Location
Location can play a large role in determining a sensible loan amount.
Urban centers have more people, In rural areas, if a unit becomes

businesses, and prospective tenants. unexpectedly vacant, it is often
Higher premiums are due to closer harder to find a tenant. This
proximity to businesses and transit. disrupts cash flows.
Class A Class B Class C Adj. for rural/non-prime areas:
Vacancy Allowances….
Highly desirable, Older buildings Need significant
prime locations, requiring updates work and are far Min. Debt Service Req.….
and built and areas with from the central
recently zoning changes business district
Loan to Value (LTV)…

Underwriting Parameters – Location

of the property
Location Urban vs. rural. “A”, “B”, or “C” class property? Adjustment to minimum DSC, LTV, or
vacancy allowance

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 Shorter Interest Smaller Maximum

Amortization Terms LTV
Proposed structures also depend on whether the lender is a cash flow lender or an equity lender.

Underwriting Parameters – Cash Flow

of the property
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? Adjustment to maximum loan
Determined by lease terms; limited ability to amount, LTV, or amortization period
increase. Stability?

Commercial Real Estate Process
Commercial Real Estate Process & Timeline
Tenants Bldg. Condition Report

Building Condition Appraisal
Cap Rate Enviro. Report Remove “Subjects”
Location Copies of Leases “Subject to” Conditions
Preliminary Due Diligence Subject Removal Closing
Analysis
7–10 days 30–45 days
45–90 days
Property Financing Legal Diligence &

Search Negotiation Approval Documentation
Purchase Price Legal Counsel
Due Diligence Period Loan Agreements
Timeline to Closing Registering Security
Transferring Funds

Loan Advance & Security Registration
Requests
Negotiates
commitment
terms
letter &
& price Purchaser
Vendor appraisal Lender
(Borrower)
Wishes to sell Puts deposit down Commissions appraisal

Calls agent Makes “subject to” conditions Starts due diligence
Orders environmental report

Once satisfied
Commitment
letter &
Purchaser financing approval
Vendor Lender
(Borrower)
Remove “subjects”
45 days to close

Purchaser
Vendor Lender
(Borrower)
Loan & security

agreements
Vendor’s Purchaser’s Lender’s

Counsel Counsel Counsel

Purchaser
Vendor Lender
(Borrower)
Reviews &
executes
Loan &
security
Vendor’s Purchaser’s documents Lender’s

Purchaser
Vendor Lender
(Borrower)


Purchaser
Vendor Lender
(Borrower)
Discharge
existing
Vendor’s registrations Purchaser’s Lender’s
Register mortgage

Purchaser
Vendor Lender
(Borrower)


Purchaser
Vendor Lender
(Borrower)


Conclusion
Conclusion
Looked at the differences and Examined underwriting Compared equity lending and
similarities between commercial criteria for different cash flow lending and analyzed
real estate loan types commercial mortgages borrowing scenarios
Explored the end-to-end process

of a commercial real estate
transaction and the timeline to
completion

Real Estate Fundamentals Course Presentation

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Real Estate Fundamentals Course Presentation

Uploaded by

Copyright:

Available Formats

Real Estate Fundamentals

Corporate Finance Institute®

Corporate Finance Institute®

Corporate Finance Institute®

Estate Represents “all things which are owned by a person.”

Corporate Finance Institute®

Real Estate Equity Fixed Income

Corporate Finance Institute®

Mutual Funds ETFs

Real Estate REITs Properties

Corporate Finance Institute®

Corporate Finance Institute®

Multifamily properties are residential sites.

Corporate Finance Institute®

Amenities Min. # Units

Many Floors Fewer Units

Large Towers Smaller

High Rise Low Rise

Corporate Finance Institute®

Advantages of multifamily structures:

• Residential tenancy is less levered to economic cycles –

• With government-backed residential mortgage insurance,

Corporate Finance Institute®

Disadvantages of multifamily structures:

• Residential leases only last 12 months, converting to

• Constant turnover with varying tenant start and end dates

• Lack of pricing power due to tenant protections stopping

Corporate Finance Institute®

Corporate Finance Institute®

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

• Sometimes, national franchisors provide corporate guarantees

Corporate Finance Institute®

Owner and Lender is more

Corporate Finance Institute®

Office properties serve the needs of a variety of white-collar industries.

Corporate Finance Institute®

Office properties serve the needs of a variety of white-collar industries.

02 Includes specialty sites

Corporate Finance Institute®

Heavy Industrial Light Industrial

Large Standalone Sites Less Customization

Significant Customization Usually warehouse facilities

Corporate Finance Institute®

If the tenant goes out of business…

Unlikely to find a new tenant that

Large Standalone Sites

Significant Customization Many costly modifications required

Heavy Manufacturing Features

Usually Single Tenant Thus, light industrial properties are more

Corporate Finance Institute®

Corporate Finance Institute®

Restaurants Bars Night Clubs

Corporate Finance Institute®

Access to the power grid, water, and sewer

Corporate Finance Institute®

If a business owns the facility in which it operates, it is called owner-occupied commercial

Corporate Finance Institute®

• 20 employees; no plans for growth John should buy the building.

• Most staff within 15-minute commute • Has capital to use as a down

• His firm would have location

Corporate Finance Institute®

• Bond yields are low; borrowing costs are low.