There are many ways that you can go about growing your assets for the future. One surefire method that experts in the industry use is obtaining real estate. There is a lot of power behind owning property, and it can open up many doors for you. For you to be able to get the property that you desire, you will need to know the basics about commercial real estate loans. Here are a few helpful bits of information about how you can go about obtaining the right loan for your needs.
What is a Commercial Real Estate Loan?
A commercial real estate loan is a type of financing specifically used for the acquisition, development, or refinancing of commercial properties. These properties include a wide range of real estate assets such as office buildings, retail centers, industrial warehouses, multi-family apartment complexes, and special-purpose properties like hotels and healthcare facilities. The primary purpose of these loans is to support businesses in securing and improving spaces where they can operate and generate income.
The structure of commercial real estate loans typically includes several key components. One is the loan-to-value (LTV) ratio, which is the ratio of the loan amount to the appraised value of the property, usually ranging from 65% to 80%. Another crucial element is the debt service coverage ratio (DSCR), which measures the property’s ability to generate enough income to cover its debt obligations, with a common minimum requirement of 1.25. Interest rates on these loans can be fixed or variable, and terms often range from 5 to 20 years, with longer amortization periods that might result in a balloon payment at the end.
For a further look into funding a commercial real estate investment, check out our video below:
Types of Loans
There are several types of commercial property loan programs, each designed to meet specific financing needs. Here are the most common types:
Permanent Loans: These are long-term loans used for the purchase or refinancing of stabilized, income-producing commercial properties. They typically have terms ranging from 5 to 30 years and can offer fixed or variable interest rates. Permanent loans are suitable for properties that have been leased out and generate steady cash flow.
Construction Loans: These short-term loans are used to finance the construction of new commercial buildings or significant renovations of existing properties. Construction loans usually cover the cost of land, labor, materials, and permits. They are typically interest-only during the construction period, with the principal being repaid once the project is completed and either refinanced with a permanent loan or sold.
Bridge Loans: Bridge loans provide short-term financing to bridge the gap between the purchase of a new property and the arrangement of long-term financing or the sale of an existing property. They are often used in situations where immediate funding is needed and are characterized by higher interest rates and shorter terms, typically 6 months to 3 years.
SBA Loans: Loans guaranteed by the Small Business Administration (SBA), such as the SBA 7(a) and SBA 504 loans, are designed for small businesses that occupy at least 51% of the property. The SBA 7(a) loan can be used for a variety of purposes, including real estate, while the SBA 504 loan is specifically for purchasing fixed assets, including real estate. These loans offer competitive terms and lower down payment requirements.
Hard Money Loans: These are short-term loans provided by private lenders based on the value of the property rather than the creditworthiness of the borrower. Hard money loans typically have higher interest rates and are used for properties that need significant rehabilitation or for quick acquisitions where traditional financing is not feasible.
Commercial Mortgage-Backed Securities (CMBS) Loans: These loans are pooled together with other commercial mortgages and sold as securities to investors. They offer long-term, fixed-rate financing and are available for a variety of property types. CMBS loans are often non-recourse, meaning the lender cannot pursue the borrower personally if the loan defaults, except under certain conditions.
Mezzanine Loans: A hybrid of debt and equity financing, this type of financing is typically used by borrowers who need additional capital beyond what senior financial institutions provide. They are secured by the equity in the property rather than the property itself. Mezzanine loans often carry higher interest rates but can be a useful tool for filling the financing gap in large commercial projects.
Blanket Loans: These loans cover multiple properties under a single loan agreement, making them suitable for investors who own several properties. Blanket loans offer the convenience of managing one loan instead of multiple loans and can provide the flexibility to sell individual properties without triggering loan defaults.
Lite Doc and Full Doc Commercial Mortgages: These loans are game-changers for investors seeking flexibility, speed, and robust terms. With our Lite Doc and Full Doc Commercial Mortgages, you can enjoy all of the benefits of a standard bank loan with higher leverage and faster turnaround times, plus up to a 30-year amortization period that makes it easier to manage your payments and keep them affordable.
Each type of commercial lending has its own set of terms and best-use scenarios, allowing borrowers to choose the option that best fits their specific financial needs and investment goals. If you’re unsure about the option that best fits your needs, contact Express Capital Financing today and let us help you.
Differences between a Commercial Loan and a Residential Loan
Commercial real estate loans and residential mortgages differ significantly in their purposes, terms, interest rates, fees, and eligibility criteria. Here are the key differences:
1. Purpose and Property Type
Commercial Real Estate Loans: These loans finance properties intended for business use, such as office buildings, retail centers, industrial warehouses, hotels, and multi-family apartment complexes with five or more units.
Residential Mortgages: These loans finance properties for personal or family use, including single-family homes, condominiums, townhouses, and multi-family buildings with up to four units.
2. Loan Amount and Terms
Commercial Loans: Typically involve larger loan amounts due to the higher value of commercial properties. Terms usually range from 5 to 20 years, with an amortization schedule that may extend beyond the loan term, often resulting in a balloon payment at the end.
Residential Mortgages: Generally have smaller loan amounts compared to commercial loans. Standard terms are 15 or 30 years, with fully amortizing payments throughout the loan period.
3. Interest Rates and Fees
Commercial Loans: Tend to have higher interest rates due to the increased risk associated with commercial properties. Fees and closing costs are also typically higher, including appraisal fees, legal fees, origination fees, and more.
Residential Mortgages: Usually have lower interest rates because they are considered less risky. Fees are generally lower, making them more affordable for individual borrowers.
4. Eligibility and Underwriting
Commercial Loans: Require a thorough analysis of the property’s income potential, the borrower’s business financials, and market conditions. Lenders consider factors such as the debt service coverage ratio (DSCR) and loan-to-value (LTV) ratio to assess risk.
Residential Mortgages: Focus primarily on the borrower’s personal financial situation, credit score, debt-to-income ratio, and employment history. The underwriting process is generally more straightforward and standardized.
5. Repayment Structure
Commercial Loans: Often structured with terms that require periodic interest payments with a large balloon payment at the end of the term, necessitating refinancing or a lump-sum payoff.
Residential Mortgages: Typically feature fully amortizing payments, meaning the loan is paid off in equal installments over the term, with no balloon payment at the end.
6. Regulatory Environment
Commercial Loans: Subject to fewer consumer protection regulations, as they are considered business-to-business transactions.
Residential Mortgages: Subject to stringent consumer protection laws designed to protect individual borrowers, including regulations under the Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA).
Advantages of a Commercial Real Estate Loan
A commercial real estate loan offers several advantages for business owners to acquire, develop, or refinance commercial properties. Types of properties might include:
Office Buildings: Space leased to businesses.
Retail Properties: Shopping centers, strip malls, standalone stores.
Industrial Properties: Warehouses, manufacturing plants, distribution centers.
Multi-family Housing: Apartment buildings, condominiums.
Special Purpose: Hotels, healthcare facilities, self-storage units, etc.
Here are some benefits of obtaining a commercial real estate loan.
Funding for Large Scale Projects
One of the primary benefits is the ability to secure substantial funding for large-scale real estate projects. These loans provide the necessary capital to purchase high-value properties, undertake significant renovations, or develop new commercial buildings, which can enhance a business’s operational capacity and growth potential. By leveraging a commercial real estate loan, businesses can preserve their working capital for other essential activities, such as inventory management, marketing, and hiring.
Competitive Rates
Another significant advantage is the potential for favorable loan terms, which can make these loans a financially viable option for many businesses. With competitive interest rates, particularly from traditional lenders like banks and credit unions, borrowers can manage their debt more effectively. Additionally, the long repayment terms – often ranging from 5 to 20 years – allow for more manageable monthly payments, aligning debt service with the property’s income-generating capacity. This alignment can improve cash flow stability and predictability for the business.
Building Equity
Commercial real estate loans also offer the benefit of building equity in the property over time. As businesses make regular payments on their loans, they gradually increase their ownership stake in the property. This equity can be a valuable asset, potentially increasing in value as the property appreciates. Moreover, owning commercial real estate can provide tax advantages, such as deductions for mortgage interest and property depreciation, which can further enhance the financial benefits of these loans.
Improved Credit Profile
Lastly, securing a commercial real estate loan can improve a business’s credit profile. Successfully obtaining and repaying a significant loan can demonstrate financial stability and creditworthiness, making it easier for the business to secure additional financing in the future. This improved credit profile can open doors to better loan terms and larger financing opportunities, supporting the business’s long-term growth and expansion strategies.
Getting Approved for a Commercial Real Estate Loan
Commercial lenders look for many different factors when considering you for approval. One of the biggest areas that will be explored is your personal credit history. Your score dictates every financial decision that you intend to make in life, which means that having a bad score will not work in your favor. Before you even consider applying for commercial real estate loans, it can be a wise idea to make sure that your credit score is where it needs to be. Hold off on your investment until you have the right score. Once you do, you are allowing yourself access to better interest rates from your lender.
After you have squared away your credit history, it can be a good idea to start thinking up a business plan. The idea of a business plan is quite simple. You will need to research the commercial property you are hoping to purchase, including the information surrounding the previous businesses that have operated out of the space and any potential ideas you can see for the future. Bringing this plan to your lender is a sure-fire way to prove that you are a competent and responsible person. Commercial lenders do not want to waste money, so you need to make sure that you show that you know what you are doing with your investment. This will help you to land the commercial loans that you have been looking at. Investing in real estate is an amazing way for you to reach new levels with your finances. Before you get ahead of yourself, take the time that you need to do research. Make sure that your credit is in order, then begin formulating a business strategy for the property that has caught your eye. In the end, you will receive commercial real estate loans that will work best for your investment needs. For more information contact us today.
FAQ
Commercial real estate loans are typically used by businesses to purchase or refinance properties that are used for commercial purposes, such as office buildings, retail spaces, or industrial facilities. These loans are specifically designed for businesses rather than individuals and can be used for a variety of purposes, including purchasing new property, refinancing existing debt, or making improvements to an existing property.
The way commercial real estate loans work is that the lender provides a loan to the business, which is then used to purchase or refinance the commercial property. The loan terms, including interest rate and repayment schedule, are agreed upon between the lender and the borrower. The borrower makes regular payments on the loan, which typically include both principal and interest, until the loan is fully repaid.
Qualifying for a commercial real estate loan can be a complex process, as lenders typically have stricter requirements for these types of loans compared to residential mortgages. Here are some key factors that lenders will look at when considering your loan application:
- Creditworthiness: One of the most important factors that lenders will consider is your credit score and credit history. A higher credit score demonstrates to lenders that you are a responsible borrower and are more likely to repay the loan on time.
In general, the minimum credit score required for a commercial real estate loan is typically higher than that for a residential mortgage. While the exact requirements can vary depending on the lender and the specific loan program, most lenders will look for a credit score of at least 680 to 700 for commercial real estate loans. However, some lenders may require even higher scores, closer to 720 or above.
Having a good credit rating is important because it can impact the interest rate you receive on your loan. A higher credit score typically means lower interest rates, which can save you money over the life of the loan. Additionally, a good credit score can also make you a more attractive borrower to lenders, increasing your chances of approval.
- Business plan: Lenders will also want to see a solid business plan that demonstrates your understanding of the commercial property you are looking to purchase or refinance. This plan should outline your goals for the property and how you plan to generate income from it.
- Property value: The value of the commercial property will also be a key factor in determining your eligibility for a commercial loan. Lenders will typically require an appraisal of the property to determine its value and ensure that it is sufficient collateral for the loan.
- Debt service coverage ratio (DSCR): Lenders will also look at your DSCR, which is a measure of your business's ability to repay the loan. A higher DSCR indicates that your business generates enough income to cover the loan payments, while a lower DSCR may make it more difficult to qualify for a loan.
- Down payment: Lenders may require a down payment of 10-30% of the property's purchase price, depending on the lender and the specific loan terms. A larger down payment can improve your chances of qualifying for a loan and may also result in lower interest rates.
Overall, qualifying for a commercial real estate loan requires careful preparation and planning. By ensuring that your credit is in good shape, developing a strong business plan, and demonstrating the value of the property you are looking to finance, you can increase your chances of securing the financing you need for your commercial real estate investment.
Yes, commercial real estate loans typically require collateral in order to secure the loan. Collateral is an asset that the borrower offers to the lender as a guarantee that the loan will be repaid. In the case of commercial real estate loans, the collateral is usually the property itself.
Lenders require collateral for commercial real estate loans because they are typically larger and riskier than residential loans. The value of the property serves as security for the loan, giving the lender reassurance that they will be able to recover their funds if the borrower defaults on the loan.
In addition to the property itself, lenders may also require additional collateral, such as personal assets or other business assets. This extra security helps mitigate the risk for the lender and can potentially make it easier for borrowers to qualify for a commercial real estate loan.
To help with all of these questions and more, we've put together this handy guide on evaluating fix and flip properties.
Securing a commercial real estate loan can offer numerous benefits for businesses looking to purchase or invest in property. However, like any financial transaction, there are also risks involved in taking out a commercial real estate loan.
One of the main risks is the potential for default on the loan. If a business is unable to make their loan payments, they could face foreclosure on the property and potentially lose their investment.
While defaulting on a commercial real estate loan is a significant risk, there are steps that borrowers can take to mitigate this risk. It is important for borrowers to carefully assess their ability to repay the loan before taking on additional debt. This includes conducting thorough market research, evaluating potential income streams from the property, and ensuring that cash flow projections are realistic.
Another risk associated with commercial real estate loans is interest rate fluctuations. Interest rates on commercial loans can vary depending on market conditions, and a sudden increase in interest rates could result in higher monthly payments for borrowers. To mitigate this risk, borrowers may consider fixed-rate loans or look for options with interest rate caps.
Additionally, the overall economic climate can impact the value of the property and the ability of businesses to generate income from their investment. Economic downturns or market fluctuations can lead to decreased property values, lower rental rates, and potentially higher vacancy rates, all of which can impact a borrower's ability to repay their loan.
Yes, there are fees associated with commercial real estate loans. These fees can vary depending on the lender and the specific terms of the loan agreement. Some common fees that may be charged include:
- Origination fee: This fee is charged by the lender for processing the loan application and approving the loan. It is usually calculated as a percentage of the total loan amount.
- Appraisal fee:
When considering commercial real estate loans, it's important to be aware of the various fees that may be associated with the loan. One common fee is the appraisal fee, which covers the cost of having a professional appraiser assess the value of the property being used as collateral. This fee is typically paid upfront by the borrower and can vary depending on the size and complexity of the property.
- Closing costs
Another fee to be aware of is the closing costs, which cover expenses such as title searches, legal fees, and recording fees. These costs can add up quickly and should be factored into the overall cost of borrowing.
- Prepayment penalties
Lastly, some lenders may charge prepayment penalties if the borrower pays off the loan early. This fee is designed to compensate the lender for potential lost interest payments. Borrowers should carefully review their loan agreement to understand any potential fees and how they may impact the overall cost of the loan.
