What is the Mortgage Constant in Commercial Real Estate? (2024)

Nearly all commercial real estate investment transactions are financed with some combination of debt and equity. “Debt” is the term used to refer to the loan provided by a real estate lender and the amount of it can have a significant impact on the profitability of an investment. But, the loan terms and conditions offered by lenders can vary widely, which can make it tricky to calculate profitability given the number of scenarios. Fortunately, there is a quick and easy way to do this using a metric called the “mortgage constant.”

In this article, the mortgage constant is defined and its application in a commercial real estate investment is illustrated. When finished, readers will have a deeper understanding of this term and a practical example of how it is used to evaluate a commercial real estate investment opportunity.

At First National Realty Partners, we always use the mortgage constant as part of the evaluation of our own deals. To learn more about our current offerings, click here.

What is the Mortgage Constant?

The mortgage constant – sometimes called the loan constant – is a performance metric that measures the amount of annual debt service per dollar of loan provided by the lender. Put another way, it is the percentage of money paid each year to service a loan, given the amount of the same loan.

Why is the Mortgage Constant Important?

For an investor, the mortgage constant is important because it helps to determine the amount of money needed each year to service a commercial mortgage. When this number is compared to the amount of cash flow a property produces, a measure of profitability is the result.

How to Calculate The Mortgage Constant

The formula used to calculate the mortgage constant is the total annual loan payments divided by the amount of the mortgage loan.

Mortgage Constant = Annual Debt Service Loan Amount

To understand how this formula works, it is helpful to break down the components.

In the numerator of the equation, annual debt service can be obtained in one of two ways. First, it can be calculated based on the mortgage amount, interest rate, and amortization period. Or, it can be provided by the lender as part of the loan underwriting process.

The loan amount is just that, the amount of the loan that will be provided by the lender. During the initial phases of analysis, the exact amount may not be known so an estimate may be required.

Mortgage Constant Example

To illustrate how the mortgage constant works, an example is helpful.

Suppose that a borrower is considering the purchase of a small retail shopping center. As part of this transaction, they will obtain a $2,000,000 loan with a 6% interest rate and a 20 year amortization. In a spreadsheet or financial calculator, these inputs can be used to calculate the loan’s monthly payments of $14,328. These monthly payments can be multiplied by 12 to get annual payments of $171,943.

When the total annual loan payments are divided by the amount of the mortgage loan, the mortgage constant is calculated to be 8.60% ($171,943/$2,000,000). But, what does this mean?

In short, it means that the borrower must pay 8.60% of the loan amount per year in debt service.

Benefits and Risks of Using the Mortgage Constant

The major benefit of using the mortgage constant as part of evaluating a potential investment is that it is quick, easy to calculate, and the information needed is readily available. In addition, the result can provide valuable information about the potential profitability of a deal.

The primary drawback of the mortgage constant is that it is fixed in time. In other words, the denominator of the equation – the loan amount – changes each time a principal and interest payment is made. As a result, it should not be solely relied upon when making an investment decision. It should be used as a single data point, amongst many others.

Mortgage Constant vs. Capitalization Rate

A comparison between the mortgage constant and the cap rate is what provides valuable insight into the leverage and/or profitability of the commercial property transaction.

As a reminder, the cap rate is the ratio of a property’s net operating income (NOI) to its purchase price. It can be used as an indication of the property’s annual rate of return, assuming it was purchased with cash. The mortgage constant can be compared to the cap rate to determine if the property is profitable.

In the example above, the mortgage constant was calculated to be 8.60%. Now assume that this same property had a calculated cap rate of 9.50%. Because the mortgage constant is less than the cap rate, it is a quick way to determine that this would be a profitable investment. If the cap rate was less than the mortgage constant, it would be an indication that there is either too much leverage (debt) or that the valuation (price) is too high.

Summary & Conclusion

The mortgage constant is a property performance metric used by real estate investors to determine the amount of debt service that must be paid each year relative to the loan balance. The lower the mortgage constant, the better.

The primary benefit of this calculation is that it is quick, easy, and can be made with information that is easily obtained. The risk is that it is just a point in time because the total loan amount changes every month when a mortgage payment is made. As a result, it should not be used in isolation to make an investment decision.

The true utility of the mortgage constant can be seen when it is compared to a property’s cap rate. As long as the mortgage constant is less than the cap rate, the property is considered to be positively leveraged and/or profitable.

Interested In Learning More?

First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.

If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.

What is the Mortgage Constant in Commercial Real Estate? (2024)

FAQs

What is the Mortgage Constant in Commercial Real Estate? ›

The loan constant, also known as the mortgage constant, is the calculation of the relationship between debt service and loan amount on a fixed rate commercial real estate loan. It is the percentage of the cash paid to service debt on an annual basis divided by the total loan amount.

What is the mortgage constant formula? ›

A mortgage constant is the percentage of money paid each year to pay or service a debt compared to the total value of the loan. The mortgage constant helps to determine how much cash is needed annually to service a mortgage loan. It is calculated as dividing the annual debt service for the loan by the total loan value.

What is the RM constant on a mortgage? ›

The mortgage constant is commonly denoted as Rm. The Rm is higher than the interest rate for an amortizing loan because the Rm includes consideration of the principal as well as the interest. The Rm could be lower than the interest for a negatively amortizing loan.

What is the constant payment method? ›

Financial Dictionary - Constant payment

This means that all of the repayments are the same throughout the life of the loan, unless the interest rate changes. This is also known as the French system.

What is constant amortization? ›

Constant Amortization Loan

A loan in which the annual amortization dollar amount remains constant but the total payment amount changes.

What is a constant in real estate? ›

A loan constant, also known as a mortgage constant, is a percentage which compares the entire amount of a loan by its annual debt service. In addition to DSCR, LTV, and debt yield, a loan constant is an important metric that lenders use to determine a property's suitability for a commercial or multifamily loan.

What is the amortizing loan constant for a 6% 30 year mortgage on a $50 million dollar loan? ›

The loan constant is equal to the annual debt service divided by the original principal balance of the loan ($50,000,000). The correct answer is 0.07195 or 7.195%. If we assume annual payments, the payment amount in the other answer is correct. To get the loan constant under this scenario, divide by $50,000,000.

What is a constant in commercial real estate? ›

The loan constant, also known as the mortgage constant, is the calculation of the relationship between debt service and loan amount on a fixed rate commercial real estate loan. It is the percentage of the cash paid to service debt on an annual basis divided by the total loan amount.

What is the constant default rate? ›

The constant default rate (CDR) is the percentage of mortgages within a pool of loans in which the mortgagors (borrowers) have fallen more than 90 days behind in making payments to their lenders.

What does RM stand for in property? ›

Mortgaged Real Property means any parcel of Real Property that shall become subject to a Mortgage after the Closing Date, in each case together with all of such Credit Party's right, title and interest in the improvements and buildings thereon and all appurtenances, easem*nts or other rights belonging thereto.

Which of the following functions calculates a constant loan payment? ›

PMT, one of the financial functions, calculates the payment for a loan based on constant payments and a constant interest rate. Use the Excel Formula Coach to figure out a monthly loan payment.

Which PMT function calculates the payment for a loan based on constant payments and a constant interest rate? ›

The Excel PMT function is a financial function that calculates the payment for a loan based on a constant interest rate, the number of periods and the loan amount. "PMT" stands for "payment", hence the function's name.

When loans are amortized monthly payments are constant? ›

Amortization describes a subtle change in your loan payments over time. The cost of your monthly payments stays consistent. However, the monthly cost of interest gradually decreases from month to month. This happens because interest rates are calculated based on your loan balance, not your monthly payment.

Are amortized monthly payments constant? ›

The payment is the monthly obligation calculated above. This will often remain constant over the term of the loan. Though you usually calculate the payment amount before calculating interest and principal, payment is equal to the sum of principal and interest.

How to assume a mortgage from a deceased family member? ›

However, you'll likely need to provide a certified copy of the borrower's death certificate (and potentially the borrower's will). If you are a joint owner, you will likely have to show the deed with your name on it. Once you've assumed the loan, you can continue making payments on it or opt to refinance.

What happens if I don't reaffirm my mortgage? ›

So, if down the line, you hit another rough patch, you're still personally on the hook for your mortgage. If you don't reaffirm, the worst the mortgage company can do against you is foreclose. They cannot hold you responsible for any deficiency following foreclosure because the discharge protects you.

How does the seller get paid on an assumable mortgage? ›

Buyer needs to pay the seller their equity stake: While you'll take over the seller's mortgage and repay that over time, you're only assuming their outstanding balance. You'll still need to pay the seller the remaining cost of the home, either out of pocket or with another loan.

What is the loan to value ratio? ›

LTV ratio is a metric lenders use to compare a loan amount to the value of the asset purchased with the loan. For example, if a lender provides a loan worth half the value of the asset while the buyer covers the rest in cash, the LTV is 50%.

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