Permanent loan

A permanent loan is the mortgage a finished building carries once it is operating. It replaces the construction loan, typically with a fixed rate, a term of several years to a few decades, and payments calculated on a long amortization schedule. Because the building now has tenants and an operating history, the lender can evaluate it as an income-producing asset rather than a construction project.

Permanent loans are sized by three tests, and the smallest result wins: a maximum loan-to-value ratio, a minimum debt service coverage ratio, and sometimes a minimum debt yield, which is NOI divided by the loan amount. All three depend on the building's net operating income, which is why the rent a building achieves in lease-up determines how much permanent debt it can support.

In our illustrative building, the permanent loan is assumed at $15,600,000 at 6.5% over 30 years, producing annual debt service of $1,183,231. Against NOI of $1,851,000, that gives a coverage ratio of 1.56, comfortably above what most lenders would require, and a loan-to-value of about 51% against a value of $30,850,000 at a 6.0% cap rate.

The permanent loan is where interest rates leave their longest mark on housing costs. A construction loan lasts a few years; a permanent loan sets the debt service a building must cover for a decade or more. A rate locked in at 7.5% rather than 6.5% raises the required rent in our illustration from $2,154 to $2,264 per month, for the life of the loan.