Borrowing Against the Property’s Income Stream

When a commercial developer or commercial property purchaser applies to a bank or other lender for a permanent mortgage loan, the lender is likely to want to know a great deal about his or her credit. However, a prospective borrower’s credit is usually less important to the lender than the property’s income stream. That doesn’t mean that permanent mortgage loan lenders are only vitally interested in the property’s income stream. They are very interested in the credit of the tenants occupying the property.

For the most part, the commercial real estate industry did not rise and grow on the field of various landlords’ credit. Their tenants took the basic risks and made the ultimate commitments that spurred the growth of the industry. The risks and commitments were embodied in the leases they executed.

What about these leases made commercial real estate such an attractive investment? The tenants usually agree to pay a fixed minimum rent; (in the case of store tenants) a percentage rent based on the amount, if any, by which their gross sales exceed an agreed sales base; and a share of real estate taxes, insurance premiums and common area maintenance expenses.

The shares of taxes, insurance and common area expenses paid by the tenant are, for the most part, applied by landlords to these burdens. Percentage rent (when it comes) is a delicious dessert for the landlord–albeit a desert served infrequently. More important from the lender’s point of view is that the minimum rent is allocated first to the discharge of the mortgage debt. (The balance is kept by the landlord.) In essence, the mortgage debt repayments are drawn from the rent paid by the tenants.

Even the amount of the mortgage debt is determined, for the most part, by the amount of minimum rent payable by the tenants. As the annual rate of minimum rent increases, a landlord-developer is able to pay larger monthly installments of interest and principal to the lender. It is easy to see that, if a real estate owner is able can repay more money to the lender every month, he or she has a better chance of borrowing more money in the first place.

The term of the leases is another critical factor in determining how much money a developer is able to borrow. It is obvious that, if the lender looks principally to the tenants’ rent commitments for repayment of the loan, it is vitally concerned about how long the tenants’ rent commitments last. Lenders are willing to lend more money and for longer periods of time against the security of long-term leases than they are willing to lend in the case of short-term leases. In fact, many lenders won’t lend anything at all in the case of a short-term lease.

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