About Commercial Real Estate Loans
Commercial real estate loans are loans that business owners can use to buy or upgrade commercial properties. The property serves as collateral for the loan. Banks and private lenders offer commercial real estate loans
what is a Commercial Real Estate Loan?
Buying or renovating commercial real estate is an exciting move, marking a big step forward for your small business. But, it can also be stressful, and there’s a lot of money at stake. You need to know the ins and outs of the process before you get too far in over your head.
Unless you can support the project with your own money, you’ll need commercial real estate loans to finance the work. Fortunately, commercial real estate loans terms are long with manageable monthly payments, and have lower interest rates than many other kinds of business loans.
Maximum Loan Amount
$50K - $5M
1 - 5 years
Starting at 6.75%
As fast as 3 weeks
How to Qualify For Commercial Real Estate Loans
When you’re out searching for a loan for commercial property, you’ll likely wonder which options are best for your business’s credentials.
Commercial real estate loan requirements—as with any business loan—vary by the lender you’re working with. But since commercial real estate is such a large, capital-intensive investment, lenders look especially closely not just at you, but at the property you want to purchase as well.
Here’s what lenders will consider when you submit an application for a commercial real estate loan:
Most customers who were approved had:
**Based on The Funding Ninjas past customers.
Time in Business
Over 4 years
As with other types of business loans, the commercial real estate loans you can qualify for depend heavily on your credit score.
Commercial real estate lenders, of course, prefer to work with borrowers who have a track record of paying back their debts on time and managing their finances well. To evaluate this, lenders will look both at your personal credit score and at your business credit score.
There’s no fixed credit score that you must have to qualify for commercial real estate loans, but there’s a progressive range across lenders. The easiest-to-access commercial real estate loan lenders are hard money lenders, and they set a minimum bar for credit scores at around 550.
If your credit score is 700 and higher, you’ll have the most desirable commercial real estate loans available to you—like SBA loans and traditional mortgages from banks.
Commercial real estate lenders aren’t just looking at your personal and business finances when determining if you qualify—they’re also looking at the property you’re purchasing or renovating.
A loan for commercial property is an asset-based loan, meaning that the property itself acts as collateral for the loan. If you can’t pay back the commercial real estate loan, the lender has a lien on the real estate and legal rights to seize and sell off the property to satisfy the debt.
Since the value of the property affects the lender’s security interest in the loan, lenders will care about the property you’re purchasing and renovating. They’ll want to see a full valuation and appraisal of the property to see whether it will be sufficient to protect the lender’s assets.
If you’re planning to do a full-scale renovation, the lenders will also be interested in the after-repair value (ARV) of the property. Some lenders base the loan amount they’ll approve you for based on the ARV.
As with other small business lenders, commercial real estate lenders will also look at your time in business before approving your loan for commercial property. It’s a simple thing to look at, but it has a significant implications on what your business qualifies for.
Put simply, the younger your business is, the riskier your business is for a lender. The owner of an established business has proven that they can weather the ups and downs that come with running a small business. That gives the lender more certainty that the owner will be able to pay back the loan.
A business that has been operating for at least 2 years has the best chance of qualifying for commercial real estate loans.
The lender could also look at your previous management experience before issuing you a commercial real estate loan. Having a lot of experience running and growing a business—perhaps even a proven track-record in expanding to new locations or renovating a commercial space—will help prove that you’re a good candidate for the loan.
Commercial real estate loans are large loans that can have a significant impact on your cash flow. For this reason, lenders want to be fairly certain that you have the financial capacity to pay off the loan comfortably.
One way to prove that you have enough cash assets on hand to pay off the financing is to look at your debt service coverage ratio, or DSCR. A DSCR is a measure of a company’s cash flow available to pay its current debt obligations. This number gives a picture of whether the business will be able to service its debt on an average month or year.
Your DSCR is calculated by dividing your annual net income (your sales minus your expenditures) by your annual loan payments. Let’s say your net income is typically $300,000 in a given year, and you expect your annual loan payments will be $50,000. That means your DSCR is 6—which is extremely healthy.
A DSCR that’s greater than 1 means your business has more than enough cash coming in to make loan payments. A DSCR of 1 says that you have exactly enough cash on hand to make your loan payments—but you don’t have a cushion for unexpected costs. A DSCR of less than 1 says that your business is operating with a negative cash flow, and you don’t have enough cash on hand to meet your debt obligations.
Lenders usually look for a DSCR that’s greater than 1.2 when evaluating your commercial real estate loan qualifications.
How To Apply
Applying for a commercial real estate Loan can be very paperwork-intensive. If you go through a bank, expect the document list to be especially long and detailed. Hard money lenders and crowdfunding platforms don’t have as many commercial real estate loan requirements, but there are still some basic documents you need to have in order.
Here’s some essential paperwork to gather for your commercial real estate loan:
Documents you need:
Business Owner Information
General Property Information
Construction or Renovation Phase
Business Tax Returns
Business Debt Schedule
Personal Tax Returns
Types of Commercial Real Estate Loans
Commercial real estate is any kind of property that you use for business purposes. The term could refer to a brick and mortar store, shopping mall, office space, or manufacturing facility. Land or mixed-use properties like apartment buildings are also commercial real estate.
If you have plans to purchase new or existing commercial properties, or to renovate commercial space, you can take out commercial real estate loans to help finance the project. The property itself serves as the collateral for the loan.
Commercial real estate loans definitely aren’t one size fits all. There are several types, varying in terms of loan amounts, eligibility requirements, length of the application process, rates, and fees.
Traditional Commercial Real Estate Loan
A traditional commercial real estate loan comes from a bank. It’s what first comes to mind for most people when they think of commercial real estate financing. Banks normally lend the most amount of money, at the lowest cost. But, they’re also hard to get. Bank commercial real estate loans are typically reserved for the highest credit borrowers and for businesses that have been showing a profit for at least a couple years.
The SBA has two loan programs that can be used for real estate: the 7(a) and the 504 loan program. The 7(a) program is a general purpose business loan that you can use for many different business reasons, including buying and repairing commercial property. The term is 25 years for real estate, and rates are in the range of 7% to 9.5%. The best parts of the 504 loan are the long terms (20 or 25 years), and some of the lowest fixed rates around (starting 5%).
A commercial bridge loan is a short-term commercial loan that lets you quickly buy property or capitalize on an opportunity. When the loan reaches maturity, you either have to pay off the loan in full, or more commonly, refinance into a longer-term loan. These loans “bridge the gap” between identifying property that you want to buy or renovate and finding affordable, longer-term financing. Bridge lenders can be banks or hard money lenders.
Hard Money Loans
Hard money commercial real estate loans are short-term loans from private lenders and investors. Compared to banks, hard money lenders tend to loan smaller loan amounts, and also charge higher interest rates. But in exchange, qualifying for a hard money loan tends to be much easier than qualifying for a bank loan. In fact, many younger small businesses get their first few commercial real estate loans from hard money lenders.
Fees on Commercial Real Estate Loans
Apart from interest rates, fees also impact the cost of your commercial real estate loan. Most commercial real estate loans have fees that you’ll need to pay before you take on the loan.
You have to pay some of these fees during the underwriting process, whereas others you can bundle into the loan.
You pay the application fee when you submit your application, and origination fees usually come out of the top of the loan. Origination fees usually range from 1% to 2% of the total loan amount. Then, there are often property appraisal fees, legal costs, survey fees, and so on. Sometimes, there are also small annual fees.
You should also be aware of any prepayment penalties on your commercial real estate loan You could have a typical prepayment penalty, but there could also be an interest guarantee, defeasance, or lockout restricting you from paying early. In each of these cases, the lender benefits the longer you hold onto your loan, or they mandate a certain level of profit at the outset.
Before committing to your commercial real estate loan, ask the lender to clearly explain any and all fees that will impact your total borrowing cost. This way, you can avoid unpleasant surprises down the line.
How Commercial Real Estate Loans Work: Terms, Loan Amounts, and Rates
Many people assume that commercial real estate loans (also called commercial mortgages) are similar to residential mortgages. But that’s not really true. As you now know, there are many types of commercial real estate loans, each a little bit different. And since commercial property is securing the loan, that affects the terms, eligibility, and other factors.
Now for the nuts and bolts of commercial real estate loans: commercial loan terms, interest rates, and fees.
Residential mortgages come in two garden varieties—a 15-year term and 30-year term. But, commercial loan real estate terms are all over the map depending on which lender you opt for and the type of loan.
SBA loans and bank loans are usually fully amortizing commercial real estate loans with 20 to 25 year terms. That means you make payments in monthly installments. Initial payments go towards interest, but as you pay more, payments go towards principal.
Hard money and crowdfunded loans are much shorter-term loans, ranging from 1 to 5 years. Since hard money loans are for such a short-term, they are good for investment opportunities like fix and flips where you buy and dispose of the property within a short period of time. These loans are also good for construction/renovation, when a bank won’t work you.
Bridge loans have the shortest terms of all, usually under one year. When the term is up, you either to pay off the loan or refinance.
Many hard money lenders offer “balloon loans” with a 5 or 7-year term. A balloon loan has low interest-only payments throughout the term, and the full balance is due at the end in one big “balloon” payment.
With balloon loans, there are fixed monthly payments throughout the term, but those payments don’t cover the entire commercial loan repayment.
The monthly payments are calculated as if the loan is a traditional 25- or 30-year mortgage.
But and at the end of your 5 or 7-year term, you’ll have paid off only interest and perhaps a small portion of your principal balance—the rest that you owe your lender is due all at once.
If you’re considering a balloon commercial real estate loan, the last payment will be very high, and your cash flow should be ready for it. You should only commit to a balloon loan if you know you’ll have the cash on hand when it comes time to make the final payment.
Otherwise, you’ll have to refinance your loan or sell your business property to make the balloon payment.
Commercial real estate projects can cost a relatively small amount, or they might go up to seven figures.
The amount of capital you’ll be able to receive for your commercial real estate loan depends on two factors:
1. The value of the property you are buying or renovating
2. The type of lender you are working with
Let’s look at how both of these things affect loan size.
Loan-to-value (LTV) is the size of your commercial real estate loan relative to the value of the property you're buying. For commercial property finance, banks usually go up to 90% LTV, whereas hard money lenders usually lend only 50% or 60% LTV. Whatever the lender doesn’t cover, the borrower has to bring as a down payment.
Say you’re purchasing a $200,000 piece of property. Banks might lend up to $180,000 for good borrowers, and you will have to put up a $20,000 down payment. For the same piece of property, a hard money lender might only lend $120,000. You’ll then have to put a $80,000 down payment.
LTV also correlates with loan cost. The higher your down payment and the more skin you have in the game, the lower your interest rate will be. For instance, if you offer to put a higher down payment on a hard money loan, then the lender might offer you a lower interest rate. But across lenders, a bank will always be more affordable than a hard money lender.
Some lenders lend money based on the after repair value (ARV) for renovation projects. ARV is the estimated value of a piece of property after any intended repairs are finished. Hard money lenders often lend up to 70% ARV.
As with any small business loan, the actual interest rate you get on your commercial real estate loan depends on your type of business, its financial health, and your creditworthiness.
In general, commercial property finance tends to come in at a steeper price point than residential mortgages. This is because businesses are just riskier to lend to than people, and there’s more volatility in commercial property values.
However, the good news is that business real estate loans tend to be more affordable than other types of business loans because the property secures the loan.
You should also know that your interest rate will depend on the kind of real estate lender you work with. Banks tend to charge the lowest rates, starting at 5%. Hard money lenders and crowdfunding platforms might charge anywhere from 10% to 30%.
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