Whether you’re a subdivision developer embarking on a new project or an office building owner looking to refinance, chances are you are in need of a commercial real estate loan. Commercial real estate loans work differently from residential mortgages in terms of underwriting, structure, interest rate, and fees, and there are several types to choose from. Here is a guide.
What is a commercial real estate loan?
A commercial real estate loan is generally used to buy, build, rehabilitate or refinance commercial, industrial and other properties not occupied by their owners. This may include an office building, multiple unit rental property, medical facility, warehouse, hotel, or vacant land on which to build one or more of these types of properties. Commercial mortgages can also be used to buy and develop land on which single or multi-family homes will be built and sold.
Commercial real estate loans are secured by commercial property. Unlike a residential mortgage, the underlying asset is not a primary residence. Instead, the commercial lender guarantees the income – such as rent from tenants – and the expenses that the property will generate.
“Ideal candidates for a commercial real estate loan include borrowers who own the property and are looking to lower their interest rate by refinancing or are looking to raise capital through cash refinancing,” says Chris Moreno, CEO of Miami-based GoKapital, Inc. âAdditionally, investors who want to work with commercial properties and diversify their portfolio should explore this type of loan option. Additionally, business owners who rent a location and qualify for a commercial real estate loan may be better off obtaining financing to purchase their commercial property.
Types of commercial real estate loans
You have the choice between several types of commercial real estate loans:
- Classic commercial real estate loan, offered by banks and other lenders, with terms ranging from five to 30 years, interest rates as low as 3.5 percent, and a minimum down payment of up to 20 percent
- Commercial bridging loan, offered by various lenders, as a means of closing the funding gap until longer term funding is found; terms typically extend up to two years, with only a 10-20 percent down payment often required
- SBA loan 7 (a) up to $ 5 million for up to 25 years
- SBA 504 loan, comprising both a portion of the loan from a Certified Development Corporation (CDC) up to 40% of the loan and a bank loan up to 50% of the loan which collectively can reach a maximum of $ 5 million
- CMBS or loan led, as part of a pool of commercial real estate loans (a commercial mortgage backed security, or CMBS) sold in the secondary market; most conduit lenders fund a maximum of $ 3 million, and terms typically run for five to 10 years with amortization of 20 to 30 years
- Hard money loan, which works like a bridging loan but is usually offered by a private lender
âIf you’re looking to close a deal quickly or have less than perfect credit, you’ll likely need to work with a private lender,â says Moreno.
Commercial real estate loans are also classified by asset class. These include apartment buildings, office buildings, medical buildings, industrial buildings, and multi-unit or single-tenant assets.
âAll of these are valued differently by the lender,â says Barry Saywitz, president of The Saywitz Company, a commercial real estate brokerage firm based in Newport Beach, California. “The value of the asset will be determined by the required appraisal, and the appraisal will be determined based on the tenant’s quality, credit, payment history and rental rate, as well as the condition of the building and the expenses involved. “
Commercial loan vs residential loan
Like a residential mortgage, a commercial mortgage can be used to buy or refinance a property. However, commercial real estate loans generally have a shorter term than a residential mortgage. A business loan could have a fixed rate for five years and a term of 15 years, amortized over 20 years, for example, says James Sandagato, vice president and sales team leader at Cornerstone Bank in Worcester, Massachusetts.
âThe interest rate would adjust every five years and the balance would be due at the end of the 15-year term, called the balloon note,â Sandagato said. “The balance could then be repaid at the end of the term, or the loan can be renewed at rates, terms and conditions to be determined at that time.”
In contrast, most residential mortgages have fixed interest rates and are typically repaid over 15, 20, or 30 years.
Commercial lenders also view the property, not the borrower, as the source of debt repayment.
“With a home loan, the lender guarantees the borrower’s ability to repay by analyzing their income and creditworthiness,” explains Suzanne Hollander, a real estate lawyer and professor at Miami-based Florida International University. âA commercial lender examines the debt service coverage ratio to the income the property will generate. “
Plus, the fees and closing costs associated with a commercial real estate loan are typically much higher than those with a residential mortgage, along with the down payment. Count on a down payment of at least 20%, although up to 45% may be required.
The assessment process is also different, says Saywitz. A commercial real estate appraiser will look at the property’s potential rental income, comparable sales, and potential replacement costs. This usually takes longer than a residential appraisal which often just looks at comparable sales in the area.
When it comes to interest rates, expect to pay more for a commercial mortgage as well.
âConventional lenders today typically offer rates ranging from 3.5% to 5% and require a credit score of at least 680 for conventional business financing,â Moreno said. âPrivate lenders, on the other hand, typically offer rates of 7% to 12%. “
How to get a commercial real estate loan
There are several steps in the process of pursuing and applying for financing for a commercial property.
- Carefully assess the finances of commercial property. âLenders will not only review your credit history and financial data, but they will also thoroughly assess the underlying asset,â Moreno said.
- Determine the type of business loan you need and compare the prices. If you have a strong credit profile and your finances are healthy, you should be able to work with a bank.
- Complete a commercial real estate loan application. You will need to provide documents such as three years of personal and business tax returns, a personal financial statement, a personal balance sheet, and historical income and expenses for the property. “[This] may also include the seller’s Schedule E of his federal income tax return or a financial statement prepared by the seller, âsays Sandagato. Also be prepared to provide an up-to-date list of each tenant, the space they occupy, rental start dates, lease details, and rental agreements.
- Wait for the loan to be processed and taken out. The lender will use the information you provide to justify the property’s ability to pay off debt. âIn general, lenders want the property to be able to support a debt service coverage ratio of 1.2 to 1,â says Sandagato. “What this means is that for every $ 1 of mortgage debt on an annual basis, there is $ 1.20 of cash flow to support it.”
- Closing of the loan. Closing a commercial loan can often take longer than a residential mortgage. âRemember, the lender considers a loan to buy commercial property to be riskier than residential, so they need to do their due diligence,â Hollander said.