What is a Commercial Real Estate Loan?
Just as you would take out a home mortgage to purchase a personal property, commercial real estate loans can help you buy a commercial property or secure funding to build a new property for your business.
Commercial real estate loans help business owners like you finance the purchase, construction, or renovation of commercial properties like these:
- Apartment buildings
- Office buildings
- Retail centers
- Hotels
- Industrial buildings
- Restaurants
Most commercial real estate loans require the property to be owner-occupied, which means that your business must occupy at least 51% of the building.
How Do Commercial Real Estate Loans Work?
Commercial real estate lending is made to business entities, which are usually trusts, funds, developers, corporations, or limited partnerships.
Generally, these loans have terms that range from 5 years to roughly 20 years, although the period of amortization may be longer than the contracted term of the loan. The amortization period describes the length of time it takes a borrower to pay back the loan principal plus interest in full.
Sometimes, business entities do not have credit ratings or long financial records. In these cases, a lender may require the owners of the entity or the principals to guarantee the loan. These parties, not the business, will assume the obligation for the debt if the borrower defaults on the loan.
Guaranteeing the loan this way means that the lender will have a credit history to review, which clears some potential roadblocks.
If your lender does not require a guarantee, the property itself is considered to be the means of recovery if you default on your loan. This type of commercial real estate loan is called a non-recourse loan.
The length of your loan terms and amortization period will depend on investor credit strength and the rate your lender charges. A general rule of thumb is that the longer a loan repayment schedule, the higher your interest rate.
Commercial real estate financing loans are quite different from residential loans in some ways. For example, most commercial loan terms are considerably shorter than standard 30-year mortgages — usually 5 to 20 years. However, the amortization period might be longer. In that case, you may be required to make a lump-sum payment.
For example, a lender might generate a commercial loan with a seven-year term but an amortization period of 20 years. In this case, the lender calculates how much the monthly payments would be if the lendee paid it over 20 years.
The lendee makes these monthly payments for seven years. Then, they are required to make a final balloon payment, which covers the remaining balance on the loan.
How To Qualify?
If you’re trying to qualify for a commercial real estate loan, here are some factors to keep in mind:
Business Finances
Moreso than residential loans, commercial real estate loans come with a lot of scrutiny — especially if you’re a small business owner. Small businesses are considered to be high-risk investments since many of them struggle to succeed.
Commercial lenders will review your books to determine whether your business has the necessary cash flow to repay the loan.
Lenders will also look at your debt service coverage ratio, which is determined by taking your annual net operating income and dividing it by the annual total debt service.
Your annual total debt service is the amount you’ll have to spend paying back both the principal and interest on your debts.
In general, a ratio of at least 1.25 is required to qualify.
Business Credit
Your commercial real estate loan lender will also check your business’s credit score. If you’re taking out a commercial loan, you should have your small business structured as a business entity rather than a sole proprietorship.
Structuring your business as a sole proprietorship means that you will put your personal wealth and assets at risk if you default on your loan.
How to Get a Commercial Real Estate Loan
Getting a loan for a commercial property or qualifying for a commercial development loan starts with preparing for the application process.
Some commercial construction loan requirements include:
- Business plan
- Third-party appraisal of the commercial property
- Business tax returns
- Details regarding collateral
- Most recent three bank statements or more
- Your books, financial reports, and records
These requirements will be different if you go through a hard-money lender. Hard-money lenders typically give loans based exclusively on the property value itself and not your creditworthiness.
Improving Your Chances of Getting Approved
To improve your chances of getting approved for a commercial real estate loan, you can take these actions:
- Pay off existing debts
- Take steps to improve your credit score
- Pledge any additional collateral, if available
- Add investors or cosigners
- Agree to pay either a larger down payment or a higher interest rate
- Find a less expensive property
Business owners who have new businesses or poor credit will face more obstacles when trying to get approved for commercial real estate loans. However, you can improve your chances by taking proactive steps.
Commercial Real Estate Loan Types
There are several types of commercial real estate loans, including SBA loans, bridge loans, and bank loans.
Traditional Commercial Mortgage
Traditional commercial mortgages are similar to residential mortgages. In these cases, the commercial loan is secured by the property you’re purchasing.
Aside from that, the terms vary according to the lender.
Qualifying for traditional commercial mortgage loans is considerably more difficult than for many other commercial real estate loans. However, these commercial construction loan interest rates are often lower.
SBA 7(a) Loans
The Small Business Administration’s 7(a) loan can help you purchase buildings or land. It can also provide you with commercial construction financing as long as the real estate is owner-occupied.
You can borrow up to $5 million with an SBA loan. These loans are fully amortized and can have either fixed or variable interest rates.
SBA 504 Loan
The SBA also offers loans specifically for long-term equipment purchases or owner-occupied real estate under the 504 loan program.
With these loans, you will be responsible for at least 10% of the down payment. You can apply for loans of $25,000 to $5.5 million.
Conduit/CMBS Loans
Conduit or CMBS loans are securitized commercial mortgages, which means the lender has pooled together a variety of commercial real estate loans and then sold them to investors on a secondary market.
These loans behave differently from traditional commercial loans. For example, if you pay the loan off early, you could incur penalty fees.
Commercial Bridge Loans
Commercial bridge loans offer quick financing to help bridge the gap until you can secure long-term financing for your commercial property.
Alternative lenders are more likely to offer these loans.
CRE Loan Benefits
What benefits do CRE loans offer over other forms of financing?
- Lower interest rates
- Access to critical funds to grow your business
- Long terms, which allow you to pay slowly as your business profits increase
Investing in real estate is a tried-and-true method of strengthening your overall business portfolio.
Where to Get a Commercial Real Estate Loan
Commercial lenders and banks are good sources for commercial real estate loans.
Banks provide commercial financing for a wide variety of properties. Although they require extensive documentation and the process can be rather slow, banks offer good rates, potential discounts, and long-term financing options.
Commercial lenders are non-bank entities that provide commercial real estate loans to small and medium-sized companies. These loans offer fast approval, generally with lower overall fees. Rates and terms will vary depending on the lender and your individual situation.
At Best Lending Co, our dedicated and expert team of commercial real estate lenders brings innovative solutions to help you and your business grow. We offer a robust portfolio of CRE loans with a straightforward application process.
Are you ready to invest in a commercial property? Contact us today.
