Purchase Price

Definition of Purchase Price

In the context of commercial real estate, the Purchase Price is the total consideration agreed upon between a buyer and a seller for the acquisition of a property. It is the gross dollar amount specified in the Purchase and Sale Agreement (PSA) and represents the mutually accepted market value of the asset at the time of the transaction.

Detailed Description and Role in Commercial Mortgages

For commercial mortgage lenders, the Purchase Price serves as the primary benchmark for underwriting and risk assessment. It is not merely a transaction figure but a critical component in determining the feasibility of a loan. Below are the key ways the Purchase Price impacts a commercial mortgage:

• Loan-to-Value (LTV) Ratio: The Purchase Price is the denominator used to calculate the LTV. Lenders generally limit their exposure to a specific percentage of the property’s value (e.g., 65% to 75%). Most institutional lenders will base the LTV on the lower of the Purchase Price or the appraised value.
• Equity Requirements: The Purchase Price dictates the amount of "skin in the game" required from the borrower. The difference between the Purchase Price and the mortgage amount represents the cash equity the borrower must contribute to the deal.
• Cost Basis: Lenders use the Purchase Price to establish the borrower’s cost basis, which is compared against the property's Net Operating Income (NOI) to ensure the investment is economically sound.
• Market Validation: The Purchase Price provides a real-time data point for the lender regarding the property's worth in the current market, as it reflects what an independent buyer is willing to pay in an arm's-length transaction.

Purchase Price vs. Appraised Value

It is common for the Purchase Price and the Appraised Value to differ. While the Purchase Price is a negotiated figure, the Appraised Value is an objective opinion of value determined by a licensed third-party appraiser. If a borrower agrees to a Purchase Price that exceeds the appraised value, the lender will typically reduce the loan amount to maintain their maximum LTV relative to the appraisal. This creates a "funding gap" that the borrower must cover with additional equity.

Exclusions from the Purchase Price

In a commercial mortgage application, it is important to note that the Purchase Price typically does not include:

• Closing Costs: Such as legal fees, title insurance, and recording taxes.
• Loan Fees: Including origination fees, appraisal costs, and environmental report fees.
• Escrows and Reserves: Funds set aside for taxes, insurance, or future capital improvements.

While these costs are part of the Total Project Cost, they are usually treated separately from the Purchase Price when calculating specific loan metrics.