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Commercial Real Estate Note Guidelines - Part 1

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By Robert Duplicki      August 10, 2023

Whether you are a property owner who may create a commercial real estate note, a note buyer, a private lender, or anyone who is looking for commercial real estate financing, it can help to think like a bank. While you have much more flexibility in your financial transactions, you also lack the background and resources that make a bank operate profitably.

Much of a bank's success begins with the regulations they must follow, and the way those regulations are supervised. The Office of the Comptroller of the Currency (OCC) has much of that responsiblity. The OCC is a federal agency that charters, regulates, and supervises national banks, federally chartered savings associations,and federal branches of foreign banks in the United States. These organizations must comply with all applicable OCC rules and requirements.

In connection with the examination and supervision of banks, OCC examiners utilize part of the Comptrollers Handbook titled "Commercial Real Estate Lending." I've taken much of the reference material for this article from this resource. Unless otherwise noted, all sections in quotes below come from "Commercial Real Estate Lending."

"For purposes of this booklet, commercial real estate (CRE) lending comprises acquisition, development, and construction (ADC) lending, and the financing of income-producing real estate. Income-producing real estate comprises real estate held for lease to third parties and nonresidential real estate that is occupied by its owner or a related party."

"This booklet addresses the risks inherent in CRE lending, risks unique to specific CRE lending activities and property types, and prudent risk management."

As you review this material consider how you manage your own process that deals with seller financing or private lending. Also consider what is helpful for you to know when you deal with bank financing.


"Banks are subject to a uniform regulation on real estate lending. These regulatory standards apply to all extensions of credit that are secured by liens on or interests in real estate. The standards also apply to loans made for the purpose of financing the construction of a building or other improvements whether or not secured by real estate."

Risks Associated With CRE Lending

"From a supervisory perspective, risk is the potential that events will have an adverse effect on a bank’s current or projected financial condition and resilience. The OCC has defined eight categories of risk for bank supervision purposes: credit, interest rate, liquidity, price, operational, compliance, strategic, and reputation."

"Liquidity risk is the risk to current or projected financial condition and resilience arising from an inability to meet obligations when they come due."

Liquidity risk is something that note buyers evaluate when considering to buy a note. It's something to definitely keep in mind when structuring seller financing.

"CRE loans are ordinarily illiquid. Converting CRE loans to cash can be accomplished by (1) the bank using the loan as collateral for borrowings; (2) the bank selling the loan to an investor (either on a participation, whole-loan, or portfolio basis); (3) the bank securitizing the loan; (4) the borrower refinancing the loan with another lender; or (5) normal borrower repayment."

"Although the sale of loans through securitization can provide liquidity, there are differences in securitizing loans originated to be held by the bank versus those originated to be securitized. CRE loans originated for securitization employ underwriting, structures, and documentation that conform to standards established by market participants. This standardization permits an efficient due diligence process and results in better pricing. Loans originated to be held in the bank’s portfolio may not, however, meet the standards for this market, making securitization of these assets inefficient and likely to result in prices that represent a material discount to book value. Market disruptions after origination and before sale can reduce the liquidity of loans that were originated for securitization "

In a similar way, inadequately structured seller financing will lead to greater discounts when selling the note.

Risk Management

"Each bank should identify, measure, monitor, and control risk by implementing an effective risk management system appropriate for the bank’s size, complexity, and risk profile."

Real Estate Lending Standards.

Real estate lending policies must:

  • be consistent with safe and sound banking practices
  • be appropriate to the size of the bank and the nature and scope of its operations
  • establish loan portfolio diversification standards
  • establish prudent underwriting standards, including LTV limits that are clear and measurable
  • establish documentation, approval, and reporting requirements to monitor compliance with the bank’s real estate lending policy
  • be reviewed and approved by the board at least annually

So here is some of the viewpoint you face when applying to a bank for a commercial mortgage. When discussing "seller financing" the suggestion is often made, "be the bank." How is your viewpoint similar when considering seller financing? You're probably not being reviewed by a board of directors. That said, what standards have you established whether creating or buying real estate notes?

Underwriting Standards

Interagency Guidelines for Real Estate Lending.

The lending policies should reflect the level of risk that is acceptable to the board of directors and provide clear and measurable underwriting standards that enable the bank’s lending staff to evaluate these credit factors. The underwriting standards should address at a minimum:

  • the maximum loan amount by type of property
  • maximum loan maturities by type of property
  • amortization schedules
  • pricing structure for different types of real estate loans
  • LTV limits by type of property

Supervisory Loan-to-Value Limits

Interagency Guidelines for Real Estate Lending

Banks should establish their own internal LTV limits for real estate loans. These limits should not exceed the following supervisory limits:

Loan category SLTV limit (less than or equal to)
Loan category:Raw land SLTV limit (less than or equal to):65%
Loan category:Land development or improved lots SLTV limit (less than or equal to):75%
Loan category:Construction: SLTV limit (less than or equal to)
Loan category:Commercial, multifamily,a and other nonresidential SLTV limit (less than or equal to)80%
Loan category:One- to four-family residential SLTV limit (less than or equal to)85%
Loan category:Improved property: SLTV limit (less than or equal to)
Loan category:Commercial, multifamily, and other nonresidential SLTV limit (less than or equal to)85%>
Loan category:Owner-occupied one- to four-family and home equity SLTV limit (less than or equal to)90%

Underwriting Practices

"An important part of the underwriting process is the analysis of the borrower’s overall financial condition and resources, the financial responsibility of any guarantor, the nature and value of any underlying collateral, and the borrower’s capacity and willingness to repay as agreed."

"Underwriting includes determining whether the borrower demonstrates the capacity to meet a realistic repayment plan from available cash flow and liquidity. Cash flow from the underlying property or other indicators of borrower capacity is evaluated to determine whether, and to what extent, the borrower can adequately service interest and principal on a prospective loan."

For more input on the connection between CRE bank underwriting and the option of seller financing, look at this article Commercial Real Estate Notes Get The Job Done.

Underwriting Income-Producing CRE Loans

"The performance of income-producing CRE is significantly influenced by local and regional economic conditions. A bank must monitor conditions in the real estate market in its lending area to ensure that its real estate lending policies continue to be appropriate for current market conditions."

Likewise note buyers will look at regional considerations when evaluating notes for purchase. Some note buyers will avoid notes in states where the forclosure process is lengthy. A note broker can help you, by knowing which note buyers to approach to sell your notes.

Income-Generating Capacity of CRE

"Repayment of loans that finance income-producing CRE typically depends on the property’s ability to service debt from cash flow. Because collateral value is largely determined by a property’s NOI, it is important to analyze and understand its income-generating capacity including whether cash flow and NOI projections are reasonable and supported. Inadequately supported or questionable analysis should be challenged."

Net Operating Income (NOI) is typically defined as all income derived from the property minus all operating expenses, excluding debt service. But "Commercial Real Estate Lending" from the OCC provides a more in depth definition that is worth reviewing:

"Net operating income (NOI): Annual gross income less operating expenses. Gross income includes all income generated through the operation of the property. In addition to rents, it may include other income such as parking fees, laundry, and vending. Tenant reimbursements may also be included if the reimbursed expenses are included in the operating expenses. Operating expenses are the costs incurred in the operation and normal maintenance of a property. They do not include interest, principal, or income taxes. Although operating expenses do not include depreciation or capital items, they do include a reserve for replacing capital items (replacement reserve). The replacement reserve is imputed for underwriting purposes irrespective of whether it is actually funded."

"To determine a property’s stabilized NOI for underwriting purposes, the analysis begins with determining the gross income that a property would generate when fully leased. This is then adjusted by the application of a vacancy factor to arrive at the effective gross income. The vacancy factor may be higher or lower than actual and represents an estimate of the vacancy the property is expected to experience throughout its existence. The selection of a vacancy factor should consider vacancies in comparable properties in the same market. Variable operating expenses that are directly related to occupancy may also be adjusted to reflect the vacancy assumptions."

Appendix D: Underwriting Considerations by Property Type

If you are interested in learning more about the underwriting factors that banks consider for specific types of properties, take a look at page 123 in "Commercial Real Estate Lending." You will find information about the following types of properties: office, retail, industrial, multifamily, hospitality, residential health care, investor-owned real estate, ground leases, affordable housing loans, real estate investment trusts (REITS), and loans secured by owner-occupied properties

This concludes my curated version of "Commercial Real Estate Lending" produced by The Office of the Comptroller of the Currency. I hope that you found some ideas that you can utilize in your own way. Feel free to share it on social media. You may link to it as well .

Bonus Lesson

Shortly after publishing this article, I read another helpful article on the Best Ever Commercial Real Estate blog, titled: "7 Hidden Risks of Skipping Title Searches in Commercial Real Estate." As title insurance is such an important part of commercial real estate, I decided to add a link to this article authored by Nic McGrue, a law professor and the founder of Polymath Legal PC.

If you have a real estate note for sale, get started now. please submit a real estate note worksheet, and I will start working to produce a deal for you.

Photo by Stephen Dawson on Unsplash


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