Here’s what it will really cost to close on a commercial mortgage.
News flash: you need more cash than just the “down payment” amount to buy real estate. Even if you are refinancing real estate you already own, there will be costs associated with closing a loan. An investor needs to understand the costs inherent to financing, especially if they are planning to maximize leverage on their investment.
Costs will vary based on situation, but these are the common ones you should plan for in most cases when taking on a commercial mortgage.
Lenders often charge a fee for their staff’s time in underwriting and processing a commercial loan file. This fee should be apparent on the term sheet, and will usually be collected up front through a deposit upon term sheet execution. This fee is may be non-refundable.
Property information and financials are of utmost importance in commercial real estate, but the borrower’s credit score can still be a deal-breaker. Lenders need to dot this i.
A third party will visit, analyze, and report on the value of the property. This step is a hard requirement for federally regulated financial institutions, and is still common practice for debt funds and other private lenders. Appraisal pricing is determined by the size, location, and type of property.
Note: If an investor is financing multiple properties as a portfolio, the appraisal cost will multiply.
Checking the building and the land it sits on for any environmental problems is a required diligence step for any commercial financing. If your property passes the Phase 1 environmental report, you can avoid the added time, expense, and remediation steps recommended in a deeper Phase 2 report.
Lenders need to understand the condition of a property and whether there’s a significant amount of deferred maintenance. They’ll order a physical inspection to determine the amount of capital that is needed to fix up the property and ensure it’s safe, sturdy, and up to code. Costs will depend on size and type of asset.
The title company typically handles the actual calculation and disburses all of the payments at the closing table. Essentially, they are the dealer at that table.
What title companies also do is provide title insurance, often to multiple parties involved in the transaction, and always to a lender. Understanding the title insurance process deserves its own blog post, but it essentially protects the lender from financial loss due to the discovery of claims against a property’s title — like a broker or contractor claiming they weren’t paid for work they performed. They’ll first perform a title search to try to discover all claims before the transaction is finalized.
States and counties around the US have different rules and regulations regarding the recording of deed transfers, liens, and mortgage recording. In some locations, mortgage recording is a flat fee in the hundreds of dollars. Elsewhere, you may need to pay a percentage of the loan amount as a mortgage registration tax.
Whether the lender charges origination points, and how many, depends on the type of lender. Certain types of lenders originate at “par”, meaning they charge no points and simply make their money on the interest rate.
Many banks and credit unions will charge 0.25–0.5% of the loan amount as an origination fee. 2% and higher would be a private lender/debt fund with more expensive capital lending on riskier assets.
This fee only applies if you use a broker or platform to arrange and negotiate your commercial financing options. For arranging a small-balance commercial mortgage (<$5,000,000), you’ll typically see a fee hovering around 1–1.5% of the loan amount. If you’re unsure that your broker is worth a 1% fee for helping you with financing, check out this previous blog post:
Is your mortgage broker worth 1%?
A good commercial mortgage broker brings more to the table than financial metrics can state — things like certainty…
When reviewing a fee agreement with a commercial mortgage broker, be advised that some less-than-transparent brokers may also collect a fee from some of their lending partners, essentially “double dipping” on the fee. In the commercial financing space, this is legal and not altogether uncommon.
I don’t want to stick a firm number to this one, because it really does depend on the size of the loan and type of execution. If you’re executing a CMBS loan, you’re lucky to get out with anything less than a $15,000 price tag on the lender’s legal costs, and sometimes several multiples of that. But those are more institutional-style loans; local banks may only need to bill a few thousand dollars in legal fees to get to the closing table.
Similarly, the complexity of a deal and the investor’s level of need will determine their own lawyer’s bill. This one should usually be less than the lender’s legal costs, because the lender is drafting the loan documents among other steps in the process that require a fancy esquire.
There are several fees involved in closing a commercial mortgage loan for your property, but an investor can’t budget every last dollar in their bank account to paying them and closing the deal. Lenders also underwrite how much liquidity an investor will have after completing the purchase, and its ratio to the monthly debt service (loan payment) when determining creditworthiness. Agency lenders, for example, test to see if the borrower will have liquidity equal to 9 months of loan payments. If you need to spend all of your available cash just completing the acquisition, there’s nothing left in reserves in case problems arise in operating the property. A lender doesn’t want to end up with a defaulted loan a month or two after closing because a tenant’s late payment, or an unexpected expense, puts the property owner underwater.