What You Should Know About Commercial Real Estate Loans
Are you looking at moving your business to a new property? If you’re ready to buy a permanent home for your enterprise, it’s time to familiarize yourself with the commercial real estate loan market.
Like a mortgage you might take out on a house, commercial real estate loans are secured by liens. They’re more common for properties that will be owner-occupied and are typically used to finance the acquisition, development and construction of a property. However, unlike residential loans, commercial real estate loans aren’t always amortized over 20 years. Commercial loans are typically either intermediate term (lasting 3 years or less) or long term (lasting 5-20 years). They may be amortized or you may end up choosing a balloon loan in which you make smaller payments throughout the term, but then have to make one large payment at the end to pay off your remaining principle lest you be forced to refinance your loan or sell your property. The last payment on a balloon loan can be quite high, so it’s best to only opt for this one if you’re absolutely sure you’ll have enough money for the final payment.
For any type of loan, you’ll need an extremely detailed business plan to prove to your lender that your business is worth the risk. The underwriting process for commercial real estate is much more rigorous than it is for residential property, so be prepared to answer many questions to prove you’re a safe bet. Know that you’ll likely be stuck with interest rates that are considerably higher than those for a residential property would be; this is because businesses are considered riskier to lend to and also have shorter credit histories than individual people do. Banks, credit unions, commercial mortgage-backed security (CMBS) lenders, life insurers and the Small Business Administration (SBA) can all help you get a commercial real estate loan, though if you have a small business, it may be worth trying the SBA first to see if you can get a fixed rate that will make it easier to calculate the exact amount you owe.
There are five main types of Commercial Real Estate loans:
SBA 7(a): This is the most common type of SBA loan, although the majority are actually used for working capital, not real estate. Use this type of loan to purchase or refinance properties up to $5 million. This figure covers 85-90% of the purchase price, though note that the 10-15% down payment can be waived if you meet certain requirements, like having two years of stable cash flow and a personal credit score over 680. 7(a) loans are aimed at stimulating economic development, so they’re restricted to businesses that have been around for more than three years but still fall below certain revenue thresholds, including medical and dental practices, CPAs, attorneys, independent pharmacies, funeral homes and other professionals.
CDC/SBA 504: This loan is actually considered two loans. A traditional bank covers up to half and a Certified Development Company (CDC) chips in up to 40% of the purchase price. There is no maximum loan amount, but the company has to have a net average income below $5 million and a net worth of less than $15 million. Specifically intended to create jobs, the borrower must create or retain one job for every $65,000 issued, so these loans are best for growing companies that don’t have more than 10% for a down payment and are also actively engaged in growing their number of employees.
Traditional commercial mortgage: Traditional mortgages are issued by banks or other lending institutions and are not backed by the federal government. They’re structured similarly to residential mortgages and provide 65-85% loan to value. Borrowers should have at least 1-5 years in business and a 700+ credit score.
Commercial bridge loan: Like the name implies, these 6- to 36-month loans provide short-term funding to purchase owner-occupied properties before later refinancing with a long-term mortgage. The quick turnaround helps borrowers compete for properties with all-cash buyers. Bridge loans cover 80-90% loan to value and require a 650+ credit score, prior completion of 1-3 prior commercial projects and a debt service coverage ratio of 1.10 or more. They’re intended for property renovation and rehabilitation, though they can also cover construction, so they’re best for investors who are looking to renovate before either selling the property or refinancing.
Commercial hard money loan: Hard money loans are similar to bridge loans in that they have similar qualifications for borrowers and are offered for short terms. However, they’re not just for rehabbing properties before occupying them. Commercial hard money loans cover 80% loan to cost (when the borrower plans to both purchase and renovate) or 90% loan to value (when the property is in good condition).
Weigh the terms, fees and requirements carefully and seek input from banks, credit unions or other lending institutions to choose the loan that fits your situation. The best choice is the loan that puts your enterprise into the right location at the right price.