REA Real Estate Financing & Capital Markets 1 — Questions and Answers
Question 1: What is a 'debt service coverage ratio' (DSCR) and why do lenders use it?
- NOI divided by annual debt service; measures a property's ability to cover mortgage payments (Correct answer)
- Total revenue divided by total expenses; measures overall operating efficiency
- Net income divided by equity invested; measures the return on equity
- Gross rent divided by purchase price; measures the income multiple
Correct answer: NOI divided by annual debt service; measures a property's ability to cover mortgage payments
DSCR (NOI ÷ annual debt service) measures how many times a property's income covers its debt payments, with lenders typically requiring a minimum of 1.20–1.25x.
Question 2: What distinguishes a 'recourse' loan from a 'non-recourse' loan in commercial real estate?
- Recourse loans allow the lender to pursue the borrower's personal assets if the property value is insufficient; non-recourse loans limit recovery to the collateral (Correct answer)
- Recourse loans have floating interest rates while non-recourse loans have fixed rates
- Non-recourse loans require larger down payments than recourse loans
- Recourse loans are only available for construction financing, not permanent loans
Correct answer: Recourse loans allow the lender to pursue the borrower's personal assets if the property value is insufficient; non-recourse loans limit recovery to the collateral
With recourse debt, lenders can pursue the sponsor's assets beyond the collateral; non-recourse loans limit lender recovery to the property itself.
Question 3: What is 'mezzanine financing' in real estate capital structure?
- Subordinate debt secured by a pledge of equity interests, sitting between senior debt and equity (Correct answer)
- A short-term bridge loan used to finance acquisitions prior to permanent financing
- A form of preferred equity that receives dividends before common equity distributions
- Government-backed financing through agencies such as Fannie Mae or Freddie Mac
Correct answer: Subordinate debt secured by a pledge of equity interests, sitting between senior debt and equity
Mezzanine debt is secured by a pledge of the borrower's equity in the property-owning entity and carries higher interest rates than senior debt due to its subordinate position.
Question 4: A commercial real estate loan has an LTV of 65% and DSCR of 1.30x. What does this tell an analyst?
- The loan is conservatively structured with low leverage and income well above debt service (Correct answer)
- The property is highly leveraged and at risk of default
- The property's equity cushion is only 35% and income barely covers debt
- The loan requires additional collateral or a personal guarantee
Correct answer: The loan is conservatively structured with low leverage and income well above debt service
A 65% LTV means significant equity cushion, and a 1.30x DSCR confirms income comfortably exceeds debt payments — both indicators of conservative underwriting.
Question 5: What is a 'CMBS loan' and what is its primary advantage for borrowers?
- A commercial mortgage-backed securities loan pooled and sold to bond investors, offering competitive fixed rates (Correct answer)
- A government-insured loan program for multifamily properties administered by HUD
- A short-term construction loan with an interest reserve funded at closing
- A floating-rate portfolio loan held on a bank's balance sheet
Correct answer: A commercial mortgage-backed securities loan pooled and sold to bond investors, offering competitive fixed rates
CMBS loans are originated, pooled, and securitized into bonds sold to investors, providing competitive fixed rates and long-term non-recourse financing.
Question 6: What is 'yield maintenance' in the context of commercial real estate loan prepayment?
- A prepayment penalty that compensates the lender for lost interest by making them whole relative to Treasury yields (Correct answer)
- A clause requiring the borrower to maintain a minimum NOI yield throughout the loan term
- An interest rate cap that prevents the loan rate from exceeding a stated maximum
- A lender's requirement that net operating income grow at a minimum annual rate
Correct answer: A prepayment penalty that compensates the lender for lost interest by making them whole relative to Treasury yields
Yield maintenance requires the borrower to pay a premium equal to the present value of remaining interest payments discounted at Treasury rates, ensuring the lender receives the expected yield.
REA Real Estate Financing & Capital Markets 1
What is a 'debt service coverage ratio' (DSCR) and why do lenders use it?