Everything You Need to Know About Commercial Real Estate Funding

What Is a Commercial Real Estate Loan?

A commercial real estate loan is a form of finance used to purchase property for commercial purposes. To qualify for a commercial loan, you must have strong credit, make a down payment of 25% or more, and intend to utilize the bulk of the financed property for your own business.

Commercial real estate (CRE) is property that generates revenue purely for commercial (rather than residential) reasons. Retail malls, shopping centers, office buildings and complexes, and hotels are all examples. Commercial real estate loans, secured by liens on the commercial property, are often used to finance the purchase, development, and construction of these assets.

Banks and independent lenders, like residential mortgage lenders, are actively engaged in offering commercial real estate loans. Insurance companies, pension funds, private investors, and other sources of finance for commercial real estate include the U.S. Small Business Administration’s 504 Loan program.


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Explaining Commercial Real Estate Loans

Commercial real estate loans may be used by companies to buy an office building or retail space, similar to the way that individuals use mortgage loans to buy a house. You may utilize a commercial property loan to finance the construction of a freestanding structure, the purchase of an office in a major mixed-use business complex, or the acquisition of residential property with the intention of renting it out. Commercial real estate is any land or structure that is intended to be utilized mainly for the purpose of generating profits.

An investor may choose from a variety of commercial real estate financing methods to purchase such a property, but they need be prepared to guarantee the mortgage with a lien, or collateral.


Types Of Commercial Real Estate Loans

Traditional Commercial Real Estate Loans

Traditional commercial loans are the simplest to comprehend since they function similarly to house mortgage loans. If you fulfill the eligibility standards of a lender, you’ll be given a loan for the purchase price of your home, minus the down payment and any fees you incur. Your home will serve as security for the loan, and you will make payments according to the repayment schedule.

The terms and rates applied to each loan will vary, but borrowers may be able to obtain fixed or variable interest rates as low as 3%, as well as balloon payments — a series of smaller payments leading to one, large payoff amount — if you need to reduce monthly payments at the start of the loan term.


SBA Loans

To support the growth of small companies and to assist entrepreneurs who are unable to get financing elsewhere, the US Small Business Administration will guarantee at least a portion of loans taken out by eligible small enterprises. This guarantee enables SBA-approved lenders to give lower interest rates to businesses that would otherwise be forced to pay higher rates owing to poor credit or inability to fulfill other criteria, such as collateral or income restrictions.

Other benefits of SBA loans include: A smaller down payment is needed, as low as 10% to 15% instead of 20%.

There are two lending programs to consider if you wish to utilize an SBA loan to purchase commercial real estate:

SBA 7(a) loans: The most popular loan program offered by the SBA, the SBA 7(a), permits you to borrow up to $5 million. Collateral may be required by lenders. As of October 7, 2022, repayment periods for real estate transactions varied from 7.75% to 10.25% for variable rate loans and from 10.50% to 13.50% for fixed rate loans.

SBA 504 loans are essentially a mixture of two loans: an SBA 504 loan that finances up to 50% of the total loan amount, and a loan from a community development corporation (CDC) that normally funds approximately 40%. Your down payment is the remaining 10%. As of March 2020, real estate periods generally range from 20 to 25 years, with effective interest rates ranging from 2.85% to 4.00%.

Prepare yourself. Closing on an SBA loan may take longer than on other kinds of loans, but you may speed up the process by submitting all needed papers on time. There are also different qualifying standards based on the loan type. For example, if you ask for a 7(a) loan, you must demonstrate your capacity to repay as well as your long-term success potential.

The benefits outweigh the drawbacks, especially the possibility of lower mortgage rates and smaller down payment requirements.


Bridge Loans For Businesses

Business bridge loans, as the name indicates, are intended to bridge a financing gap. A bridge loan may be the solution if you need a large amount of cash immediately, example, to compete with other cash buyers on a real estate opportunity while you wait for permanent finance. The biggest disadvantage of these loans is that, although they might provide financing rapidly, they must also be returned promptly.

Here are some examples of common rates and terms:

  • Rates on average: 5.72% – 11.72%
  • The average loan-to-value ratio is 80%.
  • A typical loan amount is $1 million.
  • The typical maximum period is 36 months.
  • In general, strong credit is required to qualify for competitive rates, which are already higher than those for the loans listed above.
Hard Money Commercial Loans

Hard money business loans work similarly to bridge loans in that you gain access to cash immediately but must repay it soon as well. The main distinction between hard money loans and bridge loans is who you borrow from and the qualifying requirements.

Bridge loans are often provided by banks and credit unions, while hard money loans are provided by private lenders or investors. While strong credit is desirable for any loan, hard money lenders may enable people with less-than-perfect credit to qualify if they can utilize their business equity as extra security. However, such leniency may be accompanied by higher interest rates, so you should consider bridge loans from large banks before agreeing on this kind of financing.

Here are some examples of common rates and terms:

  • 10% – 18% on average
  • Loan-to-value ratio: 60% – 80% on average
  • Typical loan amount: $150,000
  • The typical maximum duration is 12 months.
  • Check for ‘hidden costs’ and request the yearly percentage rate. The rate may seem to be reasonable at 6%, but 6% every month is 72% yearly.
Someone counting bank notes

How To Qualify For A Commercial Real Estate Loan

Commercial loans are considerably different from house loans. Lenders want to be sure your business can meet the loan payments since you’ll be utilizing the property for business.

The major loan criteria are:

1. Security

Your lender will want to ensure that the loan is appropriately secured by the property. You’ll need 25% to 30% equity in the property or a 25% down payment to qualify.

Your lender will also want to ensure you have enough property insurance (their collateral). The lender will also investigate the property’s title and deed for liens or other claims.

2. Income

Lenders want to verify that you have enough money to cover your monthly costs while processing your application. The debt-service coverage ratio (DSCR) helps lenders decide. Most lenders prefer a DSCR of 1.25 or more, however it varies with each property.

To prove your income with your lender, you’ll need to give two years of tax returns – normally company and personal, since you’ll be borrowing for business but signing a personal guarantee. You’ll also need your business’s registration paperwork and operating agreement, and personal documents like a W-9 and your birth certificate or passport.

3. Credit

Your lender will likely verify your company credit score if you need a business loan. Most lenders will demand a personal guarantee, so they’ll examine your credit as well.

Most conventional loan minimums are between 660 and 680.

Lenders will also analyze your company lifespan to estimate your credit risk. For a commercial loan, you normally need one or two years in operation. As a result, the lender will have confidence in your company’s income, which will be the principal source of payback for your loan.


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