Types of Commercial Real Estate Lenders

Types of Commercial Real Estate Lenders

Commercial real estate loans are originated by thousands of different
types of lenders, either through correspondent relationships or
directly to the borrower. “Loan origination” is an industry term that
refers to the underwriting and funding of a loan. When a lender says
that its company originated $2 billion in loans, it is the same as say14 Commercial Mortgages 101
ing that the lender underwrote and funded $2 billion in loans.
Commercial real estate lenders primarily originate new loans using
two distinct methods. The first and most common way is through
correspondent relationships. The second method is by dealing directly with the borrower.
Correspondent relationships can be exclusive or nonexclusive. A
correspondent relationship is nothing more than an exclusive right
given by the commercial real estate lender to an independent, third party company, such as a mortgage banker or mortgage broker, for
the purpose of marketing and originating new loan business for the
lender. The best example of a correspondent relationship (and historically the only way that commercial real estate loans were originated for many years) involves life insurance companies. Beginning
in the 1950s, these companies saw an opportunity to reinvest hundreds of millions of dollars in cash generated from their insurance
premiums into commercial real estate loans. However, they needed
help in finding high-quality commercial real estate developers and
borrowers that were actively building and investing in the same quality of commercial properties. From that need emerged the commercial mortgage banker. The job of a commercial mortgage banker was
to search for qualified developers and borrowers who were looking
for financing on behalf of the life insurance company. These commercial mortgage bankers and brokers acted as the liaison between
the life insurance companies and the borrowers in sort of a matchmaking role. Using the life insurance company’s money, a commercial mortgage banker merely table funded the loan in exchange for a
fee for originating and underwriting the loan. Those relationships
were usually exclusive, meaning that the only way a borrower could
contact the life insurance company was through the mortgage
banker who had the exclusive right to represent that company.
Correspondent relationships still exist, but they are now few and far
An Introduction to Commercial Real Estate Loans 15
Today, with the advent of the computer and the Internet, commercial real estate lenders are less dependent on correspondent
agencies to source and find new loans. Commercial real estate
lenders today are multifaceted finance companies with a network of
regional and branch offices from which to market their loan products. Even some of the large life insurance companies that once were
closed off to the general public are now dealing directly with anyone
that needs a commercial real estate loan. Exclusive correspondent
relationships are now on the decline, and, unlike in decades past,
both borrowers and mortgage brokers have unrestricted access to a
vast array of commercial real estate lenders.
Generally speaking, commercial real estate lenders are separated
into seven classifications: banks, life insurance companies, conduit
lenders, agency lenders, credit/finance companies, mortgage
bankers, and private lenders.


Commercial banks are the usual lenders of choice for most borrowers. That may not be surprising, since you can’t drive your car without
running into a bank branch on any given street corner. There are basically three types of banks, which really are not that distinctively different when it comes to originating commercial real estate loans. The
first type is a commercial bank. Deposits of a commercial bank are
insured by the Federal Deposit Insurance Corporation (FDIC). These
banks are either state chartered, meaning they can do business only
in their home state, or federally chartered, meaning they can conduct
business across state lines (federally chartered banks are also known
as national associations).
The second is a savings bank, or federal savings bank, which is a
remnant of the former thrifts (called savings and loans or sometimes
16 Commercial Mortgages 101
thrift and loan), whose deposits were insured by the FSLIC (Federal
Savings and Loan Insurance Corporation). The federal government
took over the thrift industry when the Federal Savings and Loan
Insurance Corporation went bankrupt in the early 1990s after the
savings and loan crisis. As a result of the savings and loan bailout,
the government required all remaining savings and loan institutions
to be renamed “savings bank.” Today, the deposits of a savings bank
are insured by the Deposit Insurance Fund (DIF).
The third type of bank is a credit union. A credit union is a cooperative financial institution that is owned and controlled by its members. Any person who has an account is a member and part owner of
a credit union. Credit unions are distinctively different from commercial banks and other financial institutions because they are not
open to the general public and are often not-for-profit cooperatives.
Deposits of a credit union are insured by the National Credit Union
Share Insurance Fund.
No matter which type of bank you are dealing with, the one thing
all three have in common is that they all rely upon customer deposits
to fund their commercial real estate loans, which explains why
depository institutions such as banks and credit unions are heavily
regulated by the federal government. There are other sources of capital that banks use to fund commercial real estate loans. These
include borrowing from other banks or from the Federal Home Loan
Bank. Imprudent or risky real estate lending can lead to a bank’s
insolvency or, worse, bankruptcy. Banks usually offer shorter loan
terms, shorter amortizations, and higher floating interest rates than
other types of lenders. In addition, they invariably require a full guarantee by the borrower, meaning that the borrower agrees to unconditionally guarantee full repayment of the loan. The advantage that
banks have over other lenders is that they can be flexible with their
loan terms, including eliminating prepayment penalties or monthly
escrows for real estate taxes, insurance, or repair reserves.

Life insurance companies

Life insurance companies are the second biggest source of commercial real estate loans. In the past, life insurance companies offered
lower interest rates than most other types of lenders because of their
low leverage. Today, however, the opposite holds true. Life insurance
companies are now charging rates 2 to 3 percentage points higher
than usual rates, thanks to the subprime mortgage crisis and the
ensuing global financial crisis that plagued the world’s economy
starting in 2009. Credit and loans for commercial real estate nearly
dried up during this period, and most life insurance companies
raised their prices to compensate them for the risk.
Life insurance companies make loans using the money they collect from the premiums they receive for the life insurance policies,
fixed-income annuities, and other financial products they sell.
Unlike banks, life insurance companies are not regulated by state or
federal banking oversight agencies and can make loans without any
restrictions. However, despite this lack of oversight, they are
extremely conservative underwriters and lend only on high-quality
commercial real estate properties, usually limiting loans up to a maximum of 75 percent of the appraised value.
Life insurance companies are extremely risk averse, and thus
they tend to look for brand-new or well-located properties in major
metropolitan cities. There are small life insurance companies that
lend as little as $500,000 and large life insurance companies that
lend up to $100 million per transaction. Life insurance companies
can be very creative and offer many types of loans for many different
types of properties, which is why mortgage bankers and brokers rely
heavily on life insurance companies. As mentioned earlier, there are
many small and medium-size life insurance companies whose
names you may not know that use exclusive correspondents for
sourcing and originating loans. Larger life insurance companies that
are still actively making commercial real estate loans, names that you
18 Commercial Mortgages 101
may recognize, include Allstate, New York Life, MetLife, and John

Conduit Lenders

A conduit lender is typically a New York Wall Street investment bank
like Morgan Stanley, JPMorgan Chase, or Goldman Sachs, which
through a distinct and separate division of the bank originates,
underwrites, and funds commercial real estate loans the same way
that residential mortgage bankers or commercial banks do for residential loans. Investment banks fund conduit loans using their own
money or borrowed money from large commercial banks, like Bank
of America, Citigroup, and Wells Fargo. Conduit loans are individual commercial mortgages that are pooled and transferred to a trust
for securitization (the process of taking a pool of commercial mortgages and converting them into fixed-income securities called commercial mortgage-backed securities or CMBS). This is almost identical to the way that residential loans are pooled by Fannie Mae and
then converted to mortgage-backed securities (MBS). These securities, also referred to as bonds, are separated into different bond
classes according to a grading system that factors in yield, duration,
and payment priority. Credit rating agencies like Fitch, Standard &
Poor’s, and Moody’s then assign credit ratings to the various bond
classes, ranging from investment grade (AAA through BBB–) to
below investment grade (BB). Once bonds are classified and given a
credit rating, they are packaged and sold to institutional investors
such as banks, foreign governments, and life insurance companies.
Wall Street investment banks primarily make their money from
underwriting, creating, and selling fixed-income securities, which
are then sold by bond dealers on the open market. These securities
or bonds are secured and backed by the commercial mortgages, and
the commercial mortgages are secured by the property such as an
An Introduction to Commercial Real Estate Loans 19
office building or retail center. The best way to explain how a conduit
loan works is by working backwards. A conduit lender begins by
using its own cash or borrowed money, for example, from a line of
credit from a big commercial bank like Citibank. The conduit lender,
which can be a Wall Street investment bank or an unrelated independent mortgage bank, then loans the money to a borrower who
needs it to purchase an office building. The term of the loan is ten
years, meaning that there is a balloon payment at the end of ten
years. The investment bank or mortgage bank is now the owner of
that promissory note (the note). However, the investment bank cannot keep the note for ten years because it borrowed the money from
Citibank using a loan with a very short term of two years. The conundrum for the investment bank or mortgage bank is that it will take
ten years to get its money back from the borrower, but in the meantime Citibank wants its loan paid off within two years. To solve that
problem, the investment bank then creates a fixed-income security or
bond that is secured by the commercial mortgage. The fixed-income
security is then sold to a long-term investor who doesn’t mind holding a ten-year bond. The money from the sale of the bond is then
used to pay back the loan from Citibank. The investment bank makes
its money when the bond is sold. Let’s say that the value of the original commercial mortgage was $5 million, which was the face
amount of the loan given to the borrower. The investment bank in
turn sells that same mortgage, packaged as a long-term bond, for a
higher price of $5.1 million, thus making a profit of $100,000. The
higher price represents a 2 percent premium paid by the long-term
institutional investor. Selling bonds at a 2 percent premium, along
with other underwriting and securitization fees, is how conduit
lenders make their money.
You may be wondering why a long-term investor would pay more
for the bond than the face amount of the mortgage. To be able to
answer that question, one needs to understand the nature of bond
20 Commercial Mortgages 101
markets. Simply put, bond investors are after yields, regardless of
price. Higher demands for securities mean higher prices. Paying a
higher price lowers the yield to the bond investor, but that is how the
bond market works. This process is what provides liquidity to the
mortgage industry and competition among commercial real estate
lenders. Higher competition among conduit lenders translates into
lower interest rates. The advantage of conduit lenders is that their
loans are typically nonrecourse. Nonrecourse loans do not require personal guarantees, thus releasing the borrower from personal liability. In addition, they offer very low long-term fixed interest rates,
longer amortization, and higher loan-to-value ratios. The disadvantage is that these loans are extremely rigid and expensive to originate.
It is also very difficult to pay off a conduit loan early, and even when
the loan can be prepaid early there are huge prepayment penalties.
In fact, most of these conduit loans have lock-out periods for years
before the loan can be prepaid in part or in whole.

Agency lenders are priva

Agency Lenders

Agency lenders are privately owned or publicly traded commercial
mortgage banking firms that originate, underwrite, and fund commercial real estate loans with their own money or with money borrowed for the sole purpose of selling these loans back to one of the
two government-sponsored agencies: Federal National Mortgage
Association (Fannie Mae) and Federal Home Loan Mortgage
Corporation (Freddie Mac). Agency lenders, however, lend money
only for residential-related commercial properties such as multifamily homes, senior housing, assisted living, student housing, and
manufactured housing. Fannie Mae and Freddie Mac were specifically created by the federal government to provide a secondary market for both single-family and multifamily loans, which in turn provides greater liquidity and affordability within the housing market.
An Introduction to Commercial Real Estate Loans 21
Unlike investment banks (conduit lenders) that make their
money selling bonds backed or secured by these commercial mortgages, agency lenders (commercial mortgage banks) make their
money originating and underwriting commercial real estate loans by
charging a loan origination fee of 1 percent. They then sell the loans
to Fannie Mae or Freddie Mac para pasu, meaning that Fannie Mae
or Freddie Mac purchases the loan at the coupon rate or face value of
the note. If the loan amount is $1 million, then Fannie Mae pays $1
An agency lender primarily makes its money by charging processing, underwriting, and loan origination fees. Agency lenders also
make money servicing the loans they sell to Fannie Mac and Freddie
Mac. Loans originated by agency lenders are underwritten using
strict Fannie Mae or Freddie Mac underwriting guidelines. Agency
lenders that fail to follow these strict underwriting guidelines risk
having their loans rejected. When a loan is rejected, the commercial
mortgage bank is essentially stuck with the loan. It can either sell the
whole loan to another bank or private lender or just hold on to it.
Agency lenders must have years of underwriting and servicing experience and be extremely well capitalized to participate in originating
and selling commercial loans to Fannie Mae and Freddie Mac.
Because of the stringent financial and capital requirements,
Fannie Mae and Freddie Mac have limited the number of preapproved agency lenders to about twenty-seven nationwide. These
twenty-seven are approved by Fannie Mae as Delegated Underwriting
and Servicing lenders, or DUS lenders, which is a special designation with many privileges. Loans purchased by Fannie Mae and
Freddie Mac are pooled, packaged, and converted into commercial
mortgage-backed securities (CMBS) the same way conduit loans are
converted to bonds. In fact, the very securitization process that conduit lenders use today was originally created by Fannie Mae for the
residential mortgage market. The commercial mortgage industry
22 Commercial Mortgages 101
began emulating Fannie Mae’s securitization process in the early

Credit Companies

Credit or finance companies are wholly owned subsidiaries or financing divisions of large corporate investment-grade companies.
General Electric (GE) is a perfect example of a global international
company that owns such a company. GE Capital is a division of GE
that makes commercial real estate loans, equipment loans, and business loans, just to name few.
Credit and finance companies are extremely well capitalized,
meaning that they have very large balance sheets and that they,
unlike banks, can lend their own money without oversight or restrictions imposed by the government. Credit companies, however, often
borrow money for their financing activities. The cost of borrowing
money is very cheap because of the parent company’s extremely high
credit and debt rating. For example, GE’s corporate credit rating is
AAA, which allows it to borrow at very low interest rates. GE’s subsidiary, GE Capital, also has access to this cheap money. This money
is then reinvested by way of commercial real estate loans at higher
interest rates to the general public.
Ratings agencies like Standard & Poors, Moody’s, and Duff &
Phelps assign debt ratings to credit companies on the basis of their
liquidity and financial strength. A company that is considered highly desirable by institutional investors has a minimum debt rating of
BBB or higher. The highest possible rating is AAA+. Companies with
the highest debt ratings can issue corporate bonds, or commercial
paper, at a very low pay rate. This ability to borrow money or raise
capital at extremely low interest rates is what gives them an advantage over banks. Loans originated by credit and finance companies
are either held as portfolio loans or securitized like conduit loans

Mortgage Bankers

Mortgage bankers are in business to originate and fund commercial
real estate loans for the sole purpose of collecting an origination fee.
A mortgage banking firm typically funds the loan with its own
money or with money borrowed through a large line of credit with a
commercial bank and then sells the loan. Mortgage bankers typically sell these loans to Wall Street investment banks and government
agencies such Fannie Mae and Freddie Mac.
Some of these bankers actually fund the loan with their own
money via a credit facility at a commercial bank or with private
funds. Mortgage bankers that do not have access to commercial credit lines or that lack the funds often table fund. Table funding is an
industry practice that allows a mortgage bank to originate, process,
underwrite, close, and record real estate loans in their own name on
behalf of an unrelated third-party lender. The closing package and
loan documents are simultaneously assigned to the unrelated thirdparty lender when funds from the third-party lender are wired to the
title company. The mortgage bank often, but not always, services the
mortgage on behalf of the third-party lender, as well. Table funding
is a way to keep a mortgage bank’s borrowing costs to a minimum.
However, mortgage banking firms usually must take a portion of the
risk loss if they want to table fund. A mortgage bank that table funds
is actually not the lender. What the mortgage bank is really doing is
only originating, underwriting, and servicing these loans. The actual
lender remains anonymous. Mortgage bankers make their money by
charging loan origination and loan servicing fees. Loan servicing is
the business of collecting the monthly mortgage payment and
escrows from the borrower on behalf of the note holder. Other
loan-servicing duties include enforcing loan covenants and paying
real estate taxes and property insurance premiums on behalf of the

Private Lenders

Private lenders are companies that raise money or capital by soliciting
individual investors through a process called syndication. Syndication
is a method used by private lenders to create a debt fund that can be
used to make commercial real estate loans. Private lenders are very
opportunistic and usually promise high returns to their investors in
exchange for their money. The anticipated high returns usually
require interest rates higher than those available from other kinds of
lenders. Private lenders are often referred to as hard-money lenders
because of their high interest rates. Private lenders are often lenders
of last resort. Borrowers are from time to time forced to seek alternative financing when properties do not qualify for traditional
financing offered by banks or conduit lenders. There are many reasons why loans are declined by traditional lenders, but that doesn’t
mean that the property is not eligible for some kind of loan. There
are many types of private lenders, some hard-money and some not.
Private lenders are not regulated by any state or federal agency, nor
are their deposits insured. In general, private lenders usually are willing to take a greater amount of risk when lending their money. They
can be creative and often lend at higher loan-to-value ratios than
other sources or lend on properties that have high vacancy rates and
little or no cash flow.

Thank you.

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