What Are Commercial Real Estate Loans?
What Are Commercial Real Estate Loans?
Are you thinking about purchasing a business property, like a warehouse or an office building? Perhaps you want to refinance your real estate debt or renew an existing property. Regardless of the issue, a commercial real estate loan may be the seamless and perfect answer.
The rates, conditions, and requirements of commercial real estate financing will all be covered in this guide. We’ll also look at the most common kinds of commercial real estate loans you can apply for in 2023.
A Commercial Real Estate Loan: What Is It?
Shopping centers, warehouses, residential buildings, and office buildings are examples of real estate that can be financed with CRE loans. A CRE loan can repay the debt on a commercial property you own, purchase new property, or rehabilitate existing income-producing real estate.
The recipient of a CRE loan is frequently a commercial organization like a corporation, developer, or trust, however, a person may also apply for one. Most of these loans need owner occupancy, meaning your company must occupy at least 51% of the property.
How Commercial Real Estate Loans Work
CRE loans work the same way as mortgage loans for personal real estate. However, the main disparity is that the loan is protected by a lien as opposed to the commercial property instead of a residential asset. A Lien refers to the legal claim to an asset that you can use as a security or warranty once a mortgage goes unpaid. For a commercial loan, the lender releases the lien once the loan has been fully repaid.
The specific loan type, lender, financed property, and other factors will all influence the terms of a commercial real estate loan. Commercial real estate loans typically come in the following forms:
Traditional Commercial Loans
When it comes to traditional commercial mortgages, there are several advantages and disadvantages to consider.
Similar to residential mortgages, commercial loans are secured by the property being purchased. However, the specific terms can vary depending on the lender. Some banks offer fully amortized loans with lengthy terms of up to 20 years and loan-to-value ratios typically reaching 80%. Conversely, other banks may provide interest-only loans with shorter 10-year terms and loan-to-value ratios capped at 65%.
Securing a traditional commercial real estate loan can be more challenging compared to other types of commercial financing. Banks generally seek business owners with strong personal credit and a high debt service coverage ratio (DSCR). A high DSCR demonstrates to lenders that your business generates sufficient revenue to meet the loan’s repayment requirements. To calculate your DSCR, you’d divide your annual net operating income by your annual debt payments, and lenders typically prefer a score of at least 1.25.
Despite the stringent eligibility criteria, traditional mortgage loans often come with lower interest rates when compared to certain alternative lending products, usually hovering within a few percentage points of a prime rate, such as the Wall Street Journal (WSJ) Prime Rate.
Pros
- Lower interest rates
- Longer terms
- Higher loan-to-value ratios
- Property secured
Cons
- Stringent qualification requirements
- Restricted flexibility
- Potentially lengthy approval process
- Big downpayment
The SBA 7(a) loan
The 7(a) loan, the SBA’s most popular loan, can be used to buy land or buildings, build new property, or renovate existing property as long as the real estate will be used for owner-occupied purposes. Through this program, a lender connected to the SBA will grant you up to $5 million.
A 7(a) loan’s interest rate cap may be fixed (11.25%), variable (8%), or both fixed and variable at the same time. The rates are determined by using either the 30-day LIBOR rate, the lowest prime rate, or the SBA optional peg rate. For 7(a) loans used for real estate, the maximum repayment period is 25 years. These loans have been paid off in full.
Pros
- Government Guarantee
- Competitive Interest Rates
- Longer Repayment Terms
- Versatile Use of Funds
- Lower Down Payments
- Options for Startups
- Support for Small Businesses
Cons
- Strict Eligibility Requirements
- Longer Application Process
- Collateral May Be Required
- Fees and Closing Costs
- Limited Loan Size
- Personal Guarantee
- Stringent Credit Criteria
504 SBA loan
Within the 7(a) system, the SBA also provides loans tailored for owner-occupied homes or the purchase of durable equipment. These loans, which go by the name of 504 loans, are made up of two separate loans: one comes from a Certified Development Company (CDC) for up to 40% of the loan amount and the other comes from a third-party lender for 50% or more of the loan amount. You, the borrower, will be required to make a down payment of at least 10%. The total project cost maybe $10 million or higher because the CDC’s loan share can range from $5 million to $5.5 million. Your loan application must be for at least $25,000 in total.
Pros
- Low fixed interest rates
- Long term financing
- Cheap down payment
- Job creation
Cons
- Lengthy application process
- Collateral guarantee
Conduit/ CMBS Loans
Conduit/CMBS loans are a type of securitized commercial mortgage where multiple commercial real estate loans are bundled and sold to investors. These loans differ from traditional commercial real estate loans in a few ways. They may have prepayment penalties for early loan payoff and more flexible requirements that can benefit business owners who don’t qualify for traditional mortgages.
Conduit loans typically finance amounts ranging from $1 million to $50 million, with loan-to-value ratios of around 75%, terms of 5 to 10 years, and 25- to 30-year amortization periods. Monthly payments remain consistent until a final balloon payment at the end of the term, and interest rates are usually fixed and competitive compared to traditional mortgage rates.
Pros
- Securitization
- Large Loan Amounts
- Competitive Interest Rates
- Flexible Eligibility
- Long-Term Financing
Fixed Interest Rates
Cons
- Prepayment Penalties
- Complex Application Process
- Balloon Payments
- Limited Use of Funds
- Potential for Collateral Requirement
- Limited Availability
Commercial Bridge Loans
To compete with all-cash property buyers, company owners can quickly obtain interim financing through commercial bridge loans, with the to refinance property has been acquired. Short periods (6 months to 3 years) are offered, and the interest rates are a little higher than the market rate. Traditional banks do not typically offer these loans; instead, alternative lenders do. The requirements are strict, requiring good credit and a low debt-to-income ratio. The approval process is shorter than for conventional real estate loans, and down payments typically vary from 10% to 20%.
Pros
- Short-Term Solution
- Quick Financing
- Competitive Edge in Property Bidding
- Faster Approval
- Flexible Use of Funds
- Ability to Refinance
Cons
- Higher Interest Rates
- Short Repayment Period
- Strong Credit Required
- Limited Availability from Traditional Lenders
- Potential for Higher Down Payment
- May Carry Additional Fees
Hard Money Loans
Hard money loans are made available by private businesses and are intended for borrowers who do not meet the requirements for conventional finance. Even if the approval procedure is frequently less stringent, the expenditures can still be very high.
Pros
- Quick funding
- Flexible approval
- Wide range of uses
- No prepayment penalties
Private lenders
Cons
- High-interest rates
- Short repayment terms
- Risk of property loss
- Limited regulation
- Higher fees
How to Qualify Commercial Real Estate Loan
The factors that lenders consider for you to qualify for commercial real estate loans. Some of these factors are the following:
- Credit Score: Lenders typically assess your credit score, though its significance may vary among loan types.
- Loan-to-Value Ratio: Lenders limit loan options based on the property’s value, expressed as a ratio. For instance, if a property is valued at $1 million with a 70% LTV limit, the maximum loan is $700,000.
- Debt Service Coverage Ratio (DSCR):
Lenders evaluate the DSCR to ensure the property generates enough income to cover debt obligations. A DSCR of 1.25x or higher is often sought. - Minimum Loan Amount: Most programs have minimum loan thresholds, usually starting at around $1 million.
- Collateral: Commercial loans typically require collateral. Non-recourse loans use only the property as collateral, while recourse loans may be offered, providing more competitive terms at the cost of personal asset protection.
Commercial Real Estate Loans: Rates and Fees
As a borrower, it is vital to become familiar with the rates and fees associated with commercial real estate loans. Here are anticipated CRE charges:
- Interest Rates: Commercial real estate loan rates are generally 0.5% to 1% higher than residential mortgage rates, based on the 30-year prime rate. Currently, rates span from 3% to 20%, contingent on loan type, property, and individual financial status.
- Repayment Term: Commercial real estate loans often have shorter repayment terms compared to residential loans, potentially making them slightly more costly.
- Closing Costs: Similar to residential mortgages, commercial real estate loans come with closing costs, typically ranging from 3% to 5% of the loan amount.
- SBA Loans: For SBA loans, borrowers may encounter a guaranty fee of up to 3.75%, which varies based on the loan amount.
How to Obtain a Loan for Commercial Real Estate
Obtaining a commercial real estate loan follows a similar procedure to obtaining a home mortgage.
- Get your documentation ready. When qualifying for a CRE loan, you’ll have to give a ton of papers outlining your finances, including your assets, liabilities, income, and credit history.
- Make a loan application. Through a bank, credit union, or online lender that provides commercial loans, you can apply for a CRE loan.
It’s crucial to be aware that the qualifying criteria for commercial real estate loans are frequently considerably stricter than those for home mortgages for individuals. Additionally, the criteria that lenders use can vary a little.
How to Prepare for a Commercial Real Estate Loan Application
You shouldn’t go into the application process without doing any research; among the questions you should ask yourself before applying are:
- Do I want to buy new real estate, renovate an existing one, or buy land?
- How much debt can my company responsibly accept?
- Do I fully comprehend all the expenses connected with my plan?
- How much time do I need for repayment?
- Do I have all the required paperwork for the lender to apply with?
You can opt to deal with a bank or an internet lender, depending on your requirements and your financial needs.
Be aware that banks typically have the most stringent standards and the longest processing delays. However, if you meet the requirements and are ready to wait, they also provide competitive rates and may be a good choice. Online lenders, on the other hand, might be more accommodating. Additionally, they function considerably more quickly and are more effective.
Even if you have low credit, certain online lenders might be able to provide you with commercial real estate loans. However, in this instance, you’ll probably have to pay premium prices. Depending on your circumstances, you might want to think about delaying financing until you improve your credit.
Which financing for commercial real estate is best for your company?
Following are some suggestions to assist you in selecting the greatest commercial real estate loan for your requirements and background:
Establish how soon you require the money.
An SBA loan or a conventional commercial mortgage loan may not be suitable if you require quick funding, such as to compete with an all-cash buyer for a business property, as the time to funding for these financing solutions can occasionally take months. A commercial bridge loan, an alternative commercial real estate loan that can be funded quickly, might be a better choice.
To reduce your options, use your qualifications.
The funding choices you can realistically receive will be constrained by your past and qualifications. If your business has a high debt service coverage ratio and you have good credit, you can be eligible for a conventional commercial mortgage loan with enticing interest rates and longer periods. Candidates with poor credit can have better luck with a hard money lender who has lax restrictions, but keep an eye out for excessive interest rates.
Compare prices.
Don’t accept the first offer you receive; instead, browse around to evaluate rates and terms with various lenders. Many business owners begin their lending connections with institutions with which they already have a history of doing business, like their bank. Since these organizations typically understand the local market better, regional and local banks are another excellent place to start. Consider if lenders conduct “soft” or “hard” credit inquiries when applying; the latter can lower your credit score.
To Sum Up
Your unique goals and financial circumstances will determine the optimal financing choice for your investment strategy. It’s crucial to look into all of your alternatives. While some might work out perfectly, others might not.
Your finance adventure begins by obtaining a commercial real estate loan. The team at GoKapital is here to help you get the finest loan possible for your investment needs. Please complete the form below, and we’ll contact you with a free estimate.
