What Is a Commercial Mortgage?
The simplest definition of a commercial mortgage is basically this: a
loan for the purchase or refinance of a commercial property. A commercial
mortgage is similar to a residential mortgage, except the collateral
is a commercial building, not residential.1 However, to fully
appreciate the complexity and broad use of the phrase, it is best to
first separate the two words and define them independently
“Mortgage” Defined
Most people think that a mortgage is the same as a loan and often
use these words interchangeably without realizing the difference.
The terms mortgage and loan have the same meaning in a colloquial
sense, but, technically speaking, the two are not the same thing. A
mortgage is actually a written legal document, referred to as a mortgage
instrument, signed by a borrower who pledges his or her title to
the property as security for the loan.2 In other words, a mortgage is a
written pledge by the borrower to the lender relinquishing the borrower’s
interest in the title to the property in the event of a default of
the loan. The term “loan,” on the other hand, refers to nothing more
than borrowed money. The legal term for a mortgage lender is mortgagee,
while the legal term for a borrower is mortgagor.
There are generally two types of mortgage instruments: mortgages
and deeds of trust.3 Both instruments create a lien against the title
to the property and represent only a transfer of the borrower’s ownership
interest in the property either to a trustee or to a lender; neither
is a transfer of the title itself. A lien is a legal claim of one person
upon the property of another person to secure the payment of a
debt or the satisfaction of an obligation.4 In layman’s terms, it is the
right to take another’s property if a debt is not paid in full. Not all
states use mortgages. For example, both California and Texas use a
deed of trust to create liens, while other states, including North
Carolina and Georgia, use mortgages. Bear in mind we are talking
about the type of mortgage instrument here. For example, just because
Texas and California use a deed of trust doesn’t mean that the lender
is not creating a mortgage, as previously defined; it’s just that different
states have different names for the “mortgage instrument” itself.
States that use either a mortgage or a deed of trust are called
“Lien Theory” states, meaning that both mortgage instruments create
a lien against the title to the property rather than transferring title
to the lender. Though both mortgage instruments create liens in the
same way, it is the foreclosure process that sets them apart. A deed
of trust differs from a mortgage in that in many states the property
can be foreclosed on by a nonjudicial sale held by the trustee.5 A nonjudicial
sale means that the trustee on behalf of the lender can go
straight to the courthouse steps and conduct a foreclosure sale of the
property without permission from any court. The foreclosure process
can be much faster for a deed of trust than for a mortgage.
Foreclosure processes that involve a mortgage almost always require
court approval before a lender can proceed with the sale of the property
to satisfy the debt.6 It is also much more time consuming and
costly to foreclose on a property using mortgages.
States that allow the lender to actually possess or hold title to the
property until the loan is paid in full under the old English common
law system are called “Title Theory” states. The best example to
explain the concept of Title Theory is a car loan. When a person buys
a car, the lender actually holds the original title until the loan is paid
in full and then returns the original paper title to the owner stamped
“paid in full.” There are only six states that still use the old English
common law type of mortgage: Connecticut, Maine, New
Hampshire, North Carolina, Rhode Island, and Vermont. In “Lien
Theory” states, title to the property is actually held by the borrower
for the benefit of the trustee and the lender until there is a default
under the loan. In the event of a default, the trustee then forecloses
on the lien on behalf of the lender.
Mortgages are created only for real estate, which is why mortgages
and deeds of trust are recorded in the real property records of
county courthouses. You will never hear a car loan, a business loan,
a personal loan, or any kind of non–real estate debt referred to as a
mortgage. Mortgages today are exclusively used for both residential
and commercial real estate loans, which may explain why the home
loan industry and residential brokerage firms prefer to use the word
“mortgage” rather than the word “loan.” Despite what may have
become natural for you to say, teach yourself to start thinking like a
professional and begin associating the word “mortgage” with the
words “lien” and “deed of trust.” In summary, if you really like using
the term “commercial mortgage” because it is natural or easy to say,
always remember that what you are really describing is a commercial
real estate loan.
“Commercial” Defined
If you look up the word “commercial” in the dictionary, you will find
that there are many definitions, depending on the context of the
usage. But what is crystal clear is that the word has no association
with real estate in any way. “Commercial” is derived from the root
word “commerce,” which has more to do with trade and business
than with real estate. So what does the word “commercial” really
mean when it is associated with mortgage or real estate? In the context
of this book, the word “commercial” can be best defined as meaning
“not residential.” Residential properties, as defined by Fannie Mae,
are limited to single-family homes and multifamily dwellings of four
units or fewer, such as duplexes, triplexes, and fourplexes. It is
because of this very narrow definition that we find the word “commercial”
convenient, because if the property is not a single-family
home, a duplex, a triplex, or even a fourplex, what other alternative
do we have but to classify it as commercial?
So up to this point we can safely say what a commercial property
is not. What then is a commercial property? As long as it doesn’t
meet the Fannie Mae definition of a residential property, a commercial
property can be any type of building or parcel of land used for
any commercial purpose. In other words, if it is not a
single-family home, a duplex, a triplex, or a fourplex, then it is simply
a commercial property. Why is this significant? It’s important
because commercial properties and commercial mortgages are as
vast as the oceans that separate the continents, and this is where residential
mortgage brokers and novice real estate investors underestimate
the complexity of the industry. Unlike the residential mortgage
industry, which is largely regulated by Fannie Mae, the commercial
mortgage industry is fragmented and extremely inconsistent.
Commercial properties and commercial mortgages can be simple or
extremely complex, depending on the property type.
Not all commercial properties are alike. There are a variety of
income-producing and non-income-producing properties that qualify
for loans and some that do not. Whether or not a particular commercial
property type qualifies for a loan also depends largely on the
type of lender. This is why it’s best to first become familiar with the
many types of commercial properties and their subsets. Lenders can
be very fickle, and you will learn quickly that not all commercial
lenders like the same kind of commercial properties. Some lenders
will lend only for apartments, while others will lend only for office
buildings, so it’s critical that you understand how to identify a commercial
property and properly describe it to the lender. If you don’t
know what kind of commercial property it is or what it is used for,
you will soon lose your credibility with the lender and possibly the
lender’s interest altogether
Typically, a commercial building is the lender’s only collateral
or security for the repayment of a commercial real estate loan. The
type, condition, age, size, and quality of the commercial building
must be described in detail for the lender’s consideration. You may
think that’s easy to do. After all, there’s no difference between a
retail center and a shopping center; they’re all the same anyway,
right? No, they’re not. For example, there are many variations
of shopping centers, such as grocery-anchored centers,
non-grocery-anchored centers (also referred to as strip retail centers),
shadowed anchored centers, neighborhood shopping centers, com-
munity shopping centers, big-box power centers, shopping malls,
and single-tenant and high-end specialty or boutique centers.
Lenders actually apply different interest rates and financing terms
according to the type of retail center. For example, interest rates are
usually lower for a grocery-anchored shopping center than they are
for a small strip retail center. This is why broad knowledge of the different
types of retail centers is important; it can mean the difference
between a high interest rate and a low one. There are hundreds of
types of commercial properties too numerous to mention, but what
we can do is highlight those commercial property types that are most
commonly sought after by commercial real estate lenders