Amortization Tables and How They Are Used for Commercial Real Estate Loans

So, you’re a commercial underwriter, and you’re working on progressing your career each and every day. A big part of this process is taking the time to understand the key financial concepts and terminologies.

The concepts and terminologies that play a significant role in the decision-making process for both lenders and borrowers. 

One such term is “amortization,” which can seem complicated at first but is essential to comprehend when working towards managing and partaking in successful real estate ventures. 

This guide aims to demystify amortization and clearly explain the ins and outs of the concepts so you can use this as a tool for your future underwriting ventures. Everything you need to know is here, so let’s get into it.

What is Amortization?

Starting with the basics, “amortization” refers to paying off a loan or debt over a specified period of time through regular, fixed payments. 

These payments consist of both principal (the original loan amount) and interest (the charge for borrowing the money).

For example, you might take out a loan for $100,000 with an annual interest rate of 5% and a term of 10 years.

Here’s how you would calculate the monthly payments and create a basic amortization schedule for the first few months:

  • Calculate Monthly Interest Rate: Convert the annual interest rate to a monthly rate by dividing it by 12. Therefore, the monthly rate = 5% / 12 = 0.004167.
  • Calculate Monthly Payment: You calculate the monthly payment using a standard loan payment formula. In this case, the monthly payment=$1,060 approximately. You can check your answer by using online mortgage calculators.
  • Determine Interest and Principal Portions of Payments: For each monthly payment, calculate how much is used to repay the interest and reduce the principal. Initially, the interest portion will be larger, but as the loan balance decreases over time, the interest decreases.
  • For the first month, the interest is calculated as $417 approximately (loan balance $100,000 x 0.004167). The principal payment would be the total monthly payment ($1,060) minus the interest ($417), which equals $643 approximately.
  • Next month, the new loan balance would be the old loan balance minus the principal portion of the first payment. In this case, $99,357 approximately ($100,000 – $643).
  • Repeat this process until all the loan has been paid off.

In a commercial real estate context, an amortizing loan is essential and provides a tone of benefits. It helps:

  • Forecast future costs (showcasing what will be owned over a predefined amount of time)
  • Ensure the investment is profitable and sustainable
  • Ensure capital is spent wisely
  • Minimize the risk involved in a commercial property investment for both the buyer and seller.
  • Define the lifespan of the loan
  • Allow for the allocation of payments
  • Identify the cost of borrowing for all parties involved

All these come together to influence investment strategies and decisions on property acquisitions ultimately and help you decide whether a loan should be given or not.

Amortization in Commercial Real Estate

What are A, B, and C Class Buildings in Real Estate?

Amortization is a common concept in both consumer and commercial loans. For example, it applies to mortgages you’d buy your home with, but there are some key concepts to understand as an underwriter.

Most notably, commercial real estate loans may have a different term and amortization. 

For instance, a loan might have a 10-year term with a 30-year amortization schedule. In such a scenario, the loan payments are calculated based on a 30-year repayment plan, but the outstanding balance (balloon payment) will be due after the 10-year term.

The Amortization Table

Sure, amortization comes with a lot of math, but it’s rather simple when you lay all your data out in a table. Here’s an example:

Alt: An example of an amortization table for a $100,000 loan

As you can see, there’s a detailed, chronological breakdown of every payment allocated towards a commercial real estate loan, helping you visualize how a loan is paid off in a transparent and understandable way.

Some of the common columns you’ll find include:

  • Payment Number: This column lists the number of payments made over the loan’s total term in chronological order.
  • Monthly Payments: This column indicates the total amount paid for each period. It remains constant throughout the loan term with an amortizing loan.
  • Interest Portion: A sizable portion of your initial payments is typically dedicated to paying off the interest. This column reveals precisely how much of your monthly payment goes towards the interest.
  • Principal Portion: This is the part of your monthly payment that reduces the outstanding principal. Initially, this may be a smaller portion of your payment than the interest. However, as you progressively pay off the interest, a larger fraction of your monthly payment is used to decrease the loan principal.
  • Outstanding Balance: This records your principal balance after each payment. Initially, this starts with the total loan amount, but with each payment, it reduces gradually until it reaches zero by the end of the loan term.

Understanding your amortization table can empower you to make strategic decisions, like structuring additional principal payments, to save on interest. 

It provides:

  • A clear, birds-eye view of how your loan progresses over time.
  • The amount of interest accumulated.
  • The balance remaining at any given time.

The Role of Amortization in Real Estate Financial Analysis

As an underwriter, amortization is your secret weapon for assessing risk and structuring smart real estate loans. But what exactly does amortization mean, and why should you care?

In short, amortization refers to how a loan’s principal balance decreases over time as payments are made. The amortization schedule clearly lays out this pay-down structure, showing the breakdown of interest vs. principal in each payment over the full loan term.

Mastering amortization analysis is crucial for commercial real estate underwriting in several key ways:

  • Cash Flow Analysis: An amortization schedule contributes critically to the property’s cash flow analysis by laying out future periodic payments. It allows investors to anticipate future cash obligations due to the loan and estimate the property’s potential profitability.
  • Assessing Investment Viability: Amortization terms can significantly impact the property’s investment returns. Longer loan terms often mean lower monthly payments but higher total interest over the loan’s lifetime. Understanding these aspects helps investors evaluate the real estate investment’s viability.
  • Cost of Capital: The amortization of debt forms a vital element of the cost of capital, influencing weighted average cost of capital (WACC) calculations and, subsequently, the valuation of the property investment.
  • Understanding Interest versus Principal Payments: Amortization schedules shed light on how each payment progressively allocates more towards the principal and less towards the interest, critical information investors require to understand loan costs.

In a broad sense, amortization can help depict a more comprehensive financial picture of a real estate investment, acting as an informative tool while analyzing acquisition, refinancing, and sale strategies.

The Difference Between Fixed-Rate and Adjustable-Rate Amortization

As you know, loan payment structures often come in two primary types: fixed-rate amortization and adjustable-rate amortization. 

Understanding their differences can help investors and borrowers determine the most suitable loan type for their unique financial circumstances and risk profiles.

Fixed-Rate Amortization

When a loan has a fixed interest rate, the interest portion and the total monthly payment stay constant throughout the loan term. 

This is possible because the interest rate does not change over time, so the amount allocated towards the principal payment also remains the same, allowing for easy and consistent planning in real estate financing.

Pros

  • Stability: Monthly payments stay the same throughout the loan term, making budgeting and planning more manageable.
  • Protection Against Interest Rate Fluctuations: Borrowers are insulated from rising interest rates in the market.

Cons

  • Potentially Higher Interest Rate: Lenders may set a higher interest rate upfront to compensate for the risk of the market interest rate increases.
  • Limited Flexibility: Borrowers might only benefit from decreasing market interest rates if they refinance their loans.

Adjustable-Rate Amortization

Adjustable-rate loans involve an interest rate that can change periodically based on a specific index and a margin, which are predetermined when the loan originated. 

Consequently, monthly payments — and, accordingly, the interest and principal portions of those payments — can fluctuate throughout the loan, leading to an altered and unpredictable amortization schedule.

Pros

  • Initial Lower Interest Rate: Adjustable-rate loans typically give borrowers a lower initial interest rate than fixed-rate loans.
  • Benefits from Decreasing Interest Rates: Borrowers can take advantage of potential market interest rate decreases without the need to refinance.

Cons

  • Uncertainty: Adjustments to interest rates can alter monthly payments, sometimes dramatically, impacting the borrower’s ability to plan and budget effectively.
  • Risk of Increasing Interest Rates: If the market interest rate increases, borrowers may face higher monthly payments, potentially affecting the property’s cash flow and investment return.

When selecting a loan type, consider factors such as risk tolerance, market interest rate trends, and the overall investment strategy to select the most suitable option for your financial landscape.

Conclusion

As you can see, amortization, a critical concept in loan management and real estate investment, provides insights into loan repayment and balance reduction. 

Its understanding benefits investors, borrowers, and real estate professionals, playing a key role in financial analysis, underwriting, and differentiating between fixed-rate and adjustable-rate amortization.

You can leverage this knowledge to enhance your financial strategy, confidently navigate loan repayment, and work toward your financial and real estate investment goals more effectively.

Ready to continue to take your underwriting career to the next level? 

Unlock your true commercial real estate underwriting potential with Next Level Financial Modeling. Master these critical concepts to make informed decisions and elevate your financial strategy. 

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