Permanent Loan

Definition of a Permanent Loan

In the context of commercial real estate, a Permanent Loan is a long-term mortgage secured by an income-producing property that has achieved stabilization. Despite the name, these loans are not truly "permanent" or infinite; rather, they are called permanent because they replace short-term, interim financing—such as a construction loan or a bridge loan—once the property’s development or renovation is complete and it is generating a steady stream of rental income.

A permanent loan typically features a term length ranging from five to thirty years. These loans are most commonly issued by life insurance companies, pension funds, CMBS (Commercial Mortgage-Backed Securities) conduits, and government-sponsored enterprises like Fannie Mae or Freddie Mac.

Detailed Description and Key Characteristics

To fully understand a permanent loan, it is essential to look at the specific structures and requirements that differentiate it from other types of commercial financing:

• Stabilization Requirement: Lenders generally require a property to reach a specific occupancy threshold (often 90% or higher) and demonstrate a consistent history of rental income before approving a permanent loan. This proves the property can support the debt service.
• Amortization vs. Term: While the loan term might be 10 years, the amortization schedule is often longer, such as 25 or 30 years. This results in lower monthly payments, but it also means a balloon payment is required at the end of the term to pay off the remaining principal.
• Interest Rates: Permanent loans usually offer the lowest interest rates in the commercial market because they represent the lowest risk to the lender. These rates are often fixed for the duration of the term, providing the borrower with predictable carrying costs.
• Debt Service Coverage Ratio (DSCR): Lenders place heavy emphasis on the DSCR, which measures the property's ability to cover the mortgage payment with its net operating income. A typical requirement is a ratio of 1.25x or higher.
• Non-Recourse Debt: Many permanent loans are non-recourse, meaning the lender's only collateral is the property itself. The borrower is not personally liable for the debt unless specific "bad boy" carve-outs (such as fraud or environmental negligence) are triggered.

The Transition from Construction to Permanent

The transition from a short-term loan to a permanent loan is often referred to as "taking out" the previous lender. In some cases, a borrower may secure a Forward Commitment, which is an agreement where a permanent lender promises to fund a loan at a future date once the construction is finished and the property meets specific performance hurdles. This provides the developer with certainty of execution and protection against rising interest rates during the construction phase.

Because permanent loans are intended for the long term, they frequently include prepayment penalties. These may be structured as yield maintenance or defeasance, which are designed to ensure the lender receives their expected yield if the borrower decides to refinance or sell the property before the loan term expires.