My son, Tommy, sent me an email this week, "Hey, Dad, what in the heck is an end loan?" Commercial mortgage-ese is the language of commercial real estate finance, and today's quick review will help us all to stay fluent.
A permanent loan is a first mortgage loan on a commercial property, with a term of at least five years and which has at least some amortization.
By "some amortization" I mean that the loan has a 25-year or 20-year amortization, as opposed to just interest-only. A 25-year amortization is the standard amortization schedule for most commercial mortgage lenders, although if your property is older than 35-years-old, many commercial lenders will insist on a 20-year amortization. After all, the property is not going to stand forever.
If the commercial first mortgage loan had a term of less than 5 years, it would be considered either a bridge loan or a mini-perm. See below for more details.
Permanent loans on commercial real estate are made by banks, credit union, and life insurance companies (life companies).
Takeout Loan or End Loan
A takeout loan is merely a permanent loan that is used specifically to pay off a construction loan. Takeout loans are also sometimes called end loans.
All takeout loans are permanent loans, but not all permanent loans are takeout loans. For example, a refinance used to pull equity out of a property would be a permanent loan but not a takeout loan.
Takeout loans are are made by banks, credit unions, and life companies.
Forward Takeout Commitment
A forward takeout commitment is merely a letter promising to pay off a construction loan at some specific time in the future, as long as certain conditions are met; i.e., the building is built according to plans and specifications, the certificate of occupancy has been issued, the property has achieved the agreed occupancy rate (typically 90% to 95%), and the effective rents meet or exceed the pro forma rents.
The lender issuing the forward takeout commitment will typically charge between one point and two points just for the letter. The takeout lender will also typically change another point or two upon funding.
Forward takeout commitments are rare modernly because few lenders want to commit to an interest rate in the future. If a life insurance company were to issue a forward takeout commitment for 4%, and interest rates were to spike up to 7%, you can bet that the developer who paid the commitment fee would "put" the commitment to the life company.
Since forward takeout commitment lenders are loathe modernly to commit to a fixed interest rate, many forward takeout commitments are written so that the interest rate floats until the loan funds. Since the takeout lender is going to require at least a 1.25 debt service coverage ratio, and since the annual payments vary according to the interest rate, it becomes impossible to pin down the future loan amount!
Therefore most construction loans today are written as opened-ended or uncovered. This means that there is no forward takeout commitment in place.
A bridge loan is a short-term loan on commercial real estate that is used to solve some temporary problem. For example, suppose a speculator is buying a half-empty strip center. The speculator cannot just go to his bank for a new permanent loan to buy the center because the property is not generating enough net operating income to service the debt (make the loan payments).
Most bridge loans have a one-year to two-year term. Often the lender will grant the borrower a six-month to one-year extension upon the payment, at the time of exercise of the extension, of a one-point or two-point extension fee.
Most bridge loans are made by mortgage funds, which specialize in short term commercial real estate loans. The rate is normally 3% to 8% higher than the rate on permanent loans, and the loan fee to the bridge lender is typically around 3 points. It's an expensive loan, but bridge lenders are usually pretty fast.
Mini-perms are short term commercial first mortgages, typically made by commercial banks at interest rates that are much lower than those offered by bridge lenders. Most mini-perms are written at a flaoting rate, typically at 1.5% to 2% over prime.
Mini-perms typically have a term of two years or three years. Occassionally a mini-perm will have a term as long as five years. Many times mini-perms are written as interest-only loans.
Mini-perms are most often created as part of a construction loan request. Rather than demanding that the developer find a forward takeout commitment (very difficult!), a commercial bank might offer its own forward takeout commitment in the form of a mini-perm. The advantage to the bank is that the bank gets to charge an extra one-point for the forward takeout commitment. In real life, the developer will seldom exercise his commitment for the mini-perm because the mini-perm has a floating rate. Yuck! Once a commercial property is completed and leased, its easy to find attractive, fixed rate financing.
The word "commercial" is just a fancy word for "business". A bank that makes loans to businesses - secured by accounts receivable, inventory, equipment, commercial real estate, and/or even just the good name of the business - is considered a commercial bank.
Bottom line: Just about every bank that you know is commercial bank.
A commercial bank is different than an investment bank. An investment bank is just a fancy name for stock broker. An investment bank takes companies public (issues Initial Public Offerings) and maintains a market in the shares of the company.