Amortization and How it Fits Into Commercial Real Estate Modeling

Written by: Lucro Staff 8 months, 4 weeks ago

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Amortization is a crucial financial concept, especially when it comes to commercial real estate modeling. Of course, there are several different types of amortization, like the amortization of loans, intangible assets, and business capital expenses.

When we discuss amortization below, we’re going to focus on the amortization of loans and mortgages. We’ll break down exactly what amortization means, how it fits into CRE modeling, and what you need to know in order to start benefiting from it.

What is Amortization?

In a broad sense, amortization is the act of paying an amount owed over multiple periods, rather than all at once. In the commercial real estate world, amortization is most often mentioned relating to the gradual elimination of a mortgage or loan over a period of time. This gradual elimination is usually achieved through regular payments over a specific time table that are sufficient enough to cover both the principal and the interest.

For commercial real estate properties, one of the most commonly recognized loan structure is a 10-year term with a 25-year amortization. This means that once the 10-year term is up, owners are expected to pay a balloon payment for the remaining original loan balance.

On the other hand, when it comes to residential home mortgages, the typical structure involves a 30-year term with a 30-year amortization. Since the amortization is the same length as the term, that means that there is no balloon payment at the end of the mortgage.

When you break it down, loan amortization is simply the liquidation of any debt over a set period of time through a series of payments. Part of the amount you pay each month goes towards covering the interest that is accruing, with the remainder paying down the principal of the loan itself.

At the beginning of your mortgage, the portion of your payment that goes towards the interest of the loan is at its highest. When you use amortization as a method of equalizing the mortgage payment over the life of the loan, the proportion of principal to interest naturally changes over time. Towards the end of the term of your loan, the interest chunk of your payments are relatively low, with the principal portion relatively higher. This allows your monthly mortgage payment to stay the same throughout the period of time you are paying it off.

The Amortization Schedule

Understanding amortization in terms of commercial real estate modeling requires the help of an amortization schedule. An amortization schedule is a table that breaks down the schedule of payments over a loan’s lifetime.

In the amortization schedule there is also a detailed account of the amount of principal and interest that needs to be paid each month. Amortization schedules are necessary for understanding the lifespan of your loan and how it can affect your financial future. Below is an example of a simple amortization schedule for a $20,000 loan with a five-year term, charging 5% interest (with monthly payments).

Month

Balance (Start)

Payment

Principal

Interest

Balance (End)

1

$ 20,000.00

$ 377.42

$ 294.09

$ 83.33

$ 19,705.91

2

$ 19,705.91

$ 377.42

$ 295.32

$ 82.11

$ 19,410.59

3

$ 19,410.59

$ 377.42

$ 296.55

$ 80.88

$ 19,114.04

4

$ 19,114.04

$ 377.42

$ 297.78

$ 79.64

$ 18,816.26

. . . .

. . . .

. . . .

. . . .

. . . .

. . . .

57

$ 1,494.10

$ 377.42

$ 371.20

$ 6.23

$ 1,122.90

58

$ 1,122.90

$ 377.42

$ 372.75

$ 4.68

$ 750.16

59

$ 750.16

$ 377.42

$ 374.30

$ 3.13

$ 375.86

60

$ 375.86

$ 377.42

$ 374.29

$ 1.57

$ 0

Amortization is a concept that is fundamental to both finance in general and commercial real estate specifically. Understanding what amortization is and how it works can help you save time and money when it comes to your real estate investment decisions.

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