This week, we're going to discuss commercial real estate notes. We'll explain in detail how to create a commercial real estate note that is valuable.

First of all, a commercial real estate note, as with any other type of real estate note, is a cash flow note which is secured by real estate. The cash flow note itself may be in the form of a mortgage or trust deed, depending on the location of the property.

The real estate securing the note, in the case of a commercial real estate note, will be an income-earning property. This property may be an apartment complex, a garage, a movie theatre, a beauty salon, a restaurant, a convenience store. It can be occupied by any type of business. However, it is important to note that commercial real estate notes are secured only by the property involved, not by the business that occupies the property. If a cash flow note is secured by a business, then the note is a business note, not a commercial real estate note.

Creating a valuable cash flow note for a commercial property is similar in many ways to creating a valuable cash flow note for a residential property. However, there are some important differences also.

As with a residential property cash flow note, the down-payment, the credit score of the payor, the seasoning on the note, the payment history on the note, and the amount of equity in the property all come into play. The terms of the note are also important. The length of the term and the interest will directly affect the value of the note.

Unlike cash flow notes secured by residential real estate, commercial cash flow note values will also be affected by the income producing ability of the property. Specifically, factors such as the annual gross rental income, the vacancy factor, the annual operating expenses of the property, the net operating expense of the property, and the debt coverage ratio must be taken into account. In addition, in some cases, the zoning of the property will become a factor, as may the current usage of the property, and the allowable uses of the property listed in its classification. If the zoning is "grandfathered" or there is some other type of variance in effect, that also might affect the value of a commercial note.

Recommendations for structuring a commercial cash flow note vary. Generally, a down-payment of at least 25% is advisable, although a down-payment of 10-15% may be acceptable if the note is very strong in other areas (i.e well seasoned, good credit score, first position, etc). The credit score of the payor should be at least 600 or above, and many cash flow note investors prefer 640 or above. Though it may be possible to sell a commercial note unseasoned, you are not likely to get good pricing for it. Notes seasoned for a minimum of 4-6 months are generally preferred. As with cash flow notes secured by residential property, a larger down-payment, longer seasoning, greater equity, and improved credit scores will make a commercial cash flow note more valuable. An unfavorable payment history, with late or missing payments, will negatively impact the value of the note. 

Senior notes on commercial properties, if structured correctly, are likely to be valuable notes which can easily be sold for cash. However, junior notes may or may not be viable notes. In this case, the 1st:2nd loan ratio should be no more than 3:1. The combined loan to value ratio (CLTV) will also play a part in determining whether the loan is sellable or not. A CLTV above 70% is likely to not be very attractive to a cash flow note investor and is not likely to sell easily.

First Class Cash Flow Handlers buys cash flow notes of any type, including commercial real estate notes. You may submit your note online, or contact First Class Cash Flow Handlers at 401-258-7158.