Commercial real estate involves properties used exclusively for business purposes, such as an office park, restaurant, or retail space. These spaces are then often leased to tenants who fill the spaces with their own businesses. Their lease will help pay for the purchased real estate property.
Investing in commercial real estate is an excellent opportunity for anyone who is looking into a unique business venture, and now is a good time to get started in the market. Commercial real estate is often more lucrative than residential, and it is easier to get an accurate price evaluation on the property.
If you are interested in investing in real estate but don’t have the cash upfront to buy a property, you can still start investing by looking into the different types of commercial real estate loans.
What is a Commercial Real Estate Loan?
Commercial real estate loans are mortgages specifically for those who intend to purchase commercial properties. Properties defined as commercial real estate can be anything from a large mall or office building to a small single-story building that is classified as retail space. They are considered commercial properties as long as they are intended for business use only, not residential.
While the primary use for commercial real estate loans is to purchase property, they can also be used for improving current properties. Common examples of reasons why businesses seek out these types of loans are:
- Expanding current retail spaces
- Buying and moving to larger warehouses
- Buying and renovating a new office park or hotel
- Funding for the purchase of land to build a commercial property
Banks, such as SouthEast Bank, and other lenders offer commercial real estate loans. Insurance companies, private investors, and even the Small Business Administration may offer capital opportunities for purchasing a property.
Residential Loans vs Commercial Real Estate Loans
While commercial real estate loans work similarly to residential mortgages, they differ because the loan is secured through a lien against the actual commercial property. A lien is a legal claim to the property that can be used as collateral if you do not pay the loan. Once the loan is paid off, the lien is removed. Also, unlike residential loans, which are either 15-year or 30-year mortgages, commercial real estate loans have shorter terms ranging from less than five years to up to 20 years, with up to 25-year amortization.
Like residential mortgages, most commercial loans are approved based on creditworthiness and often have a fixed repayment plan. The loan rate will also depend on the borrower’s credit score.
However, as with residential loans, most commercial loans are issued to borrowers classified as business entities, not individuals. A business credit score will be considered as well as the group of individuals’ credit history. A corporation, developer, funds, or limited partnership would be classified as a business entity, and often these entities are formed solely to buy commercial real estate.
Depending on the loan and the lender, a down payment may be needed, like with residential loans. Other assets besides the property that is being purchased may be put up as collateral to mitigate risk.
Types of Commercial Real Estate Loans
There are multiple types of commercial real estate loans available through many lenders, each with its own requirements. If you are interested in investing in commercial real estate or are looking for a loan to improve your current property, there are four main types of commercial real estate loans to choose from.
Understanding what each type is used for will help you decide which loan is the right one for you.
SBA loans are loans backed by the Small Business Administration and can be some of the least expensive loans for obtaining commercial real estate. There are two options for commercial real estate with SBA Loans: SBA 7(a) loans and SBA 504/CDC loans.
SBA 7(a) loans for commercial real estate
The 7(a) loans are best for smaller projects, such as improving your current business space or buying new real estate. The maximum loan amount for a 7(a) loan is $5 million, and they offer both short- and long-term working capital. SBA 7(a) loans are not strictly for commercial real estate but can be used for almost any small business need.
To qualify for an SBA 7(a) loan, you must meet the following requirements:
- Use the funds for a sound business purpose
- Demonstrate the need for a loan
- Be considered a small business as defined by the SBA
- Have businesses in the United States
- Operate for profit
- Have reasonable invested equity
SBA 504/CDC loans for commercial real estate
SBA 504/CDC loans are designed to finance commercial real estate or purchase large equipment for businesses. They often have longer-term and fixed interest rates compared to 7(a) loans, and are available through Certified Development Companies, or CDC, to help promote job and business growth.
To qualify for a 504/CDC loan, you must meet the following requirements:
- Must be a for-profit company in the United States (non-profits do not qualify)
- Have a tangible worth of less than $15 million
- Average net income of less than $5 million after federal income taxes for two years preceding your application
- Have a feasible business plan
- Good character
- Ability to pay the loan back
Conventional bank loan
Conventional bank loans are also called permanent loans and are one of the more popular choices when it comes to financing a commercial real estate investment. They are provided by traditional lenders such as banks, who will examine the business entity’s financial history and creditworthiness. Conventional bank loans are one of the best options for those with good credit as they have better rates than other forms of funding and the ability to have long-term financing. As with all loans, lenders must have documents presenting the business plan, financial history, assets, and credit reports.
The typical loan amount for a conventional bank loan is $1 million, but it can be much higher depending on the property and the purchaser’s finances.
Owner occupied commercial mortgages
Owner-occupied commercial mortgages are a popular type of conventional bank loan for commercial real estate. An owner-occupied borrower holds the title of that property and is a resident of that property. In the case of commercial property, the property in question is occupied by the operating company that controls or owns that property. They must be in control of at least 51% of the commercial space
The borrower’s business acts as a liability in case any cash-flow issues arise. Before agreeing to the loan, the lender will also look into tax returns, business debt schedules, personal tax returns, and credit history.
Commercial bridge loan
Commercial bridge loans are used to purchase commercial real estate and fix-up properties. They are flexible and offer short-term financing; they are not permanent financing.
Permanent financing is when the loans are funded based on the LTV ratio or the loan-to-value ratio. Commercial bridge loans, however, are based on the LTC, or loan-to-cost ratio. When looking at a commercial bridge loan application, lenders will consider the property’s current condition, market conditions, and any renovation plans.
Commercial bridge loans tend to come with more risk than an SBA or traditional loan, so they also come with higher interest rates and variable terms based on the property’s condition. Those considering commercial bridge loans may have lower credit scores or can’t wait for permanent financing.
Hard money loans
Hard money loans are short-term loans from private companies instead of traditional lenders. Private companies will accept the property or other assets as collateral should the loan default.
Borrowers may choose to take out a hard money loan if they are not approved by a traditional lender or want to avoid a longer approval process to move quickly on a purchase as they have a less strict approval process. Due to the nature of the loan, with a lenient approval process, the lender has a higher risk. This means hard money loans tend to be more expensive, with higher interest rates and larger down payments, if needed.
Some lenders offer a blanket commercial real estate loan if you want to buy multiple properties. Blanket loans streamline the lending process and can reduce costs associated with buying multiple properties. Having all properties under one loan allows the borrower to have one payment and one set of loan terms. If the borrower wants to sell one property out of the group under the loan, a built-in release clause allows it to be sold while the other properties remain in the loan.
The downside of a blanket loan is that all the properties are rolled together into one loan, meaning they are all collateral for one another. If one property fails to bring in cash flow, all properties could be at risk and the loan itself. They also cannot be used to buy multiple properties in different states due to varying laws and guidelines for these types of loans.
Blanket loans are best for larger companies that can afford to take the risk of multiple real estate properties at once instead of investors looking to start their journey into commercial real estate.
How to Get a Commercial Real Estate Loan
Applying for a commercial real estate loan is much like a residential mortgage. Borrowers must gather past and current business and personal financial documents, including any assets, debt, and current income.
Lenders like to see a business credit score of 75 for the best rate and at least a 660 personal credit score. Some loans may require a higher score and documentation, such as references. Many commercial real estate loans will also need a large down payment and a strong business plan to be considered.
Be sure to document the property. Depending on the type of loan, this may be one of the most important steps. Understand the value of the property and the current market, as well as any renovations you might be undertaking.
Finding the Right Type of Commercial Real Estate Loan
When you are looking for the right type of commercial real estate loan for your business, there are a few factors to take into consideration:
- What are the terms of the loan?
- What is the loan being used for – buying commercial real estate or improving a current property?
- How good is your credit score? If you have a lower credit score, you may consider a hard money loan over a conventional bank loan.
- What type of business are you? If you qualify as a small business, SBA loans are an excellent funding opportunity that can cover a variety of business expenses, excluding purchasing a new property.
The most important decision in finding the right type of commercial real estate loan is deciding on your lender. The best lender will not only help you answer the above questions and walk through the different types of loans available but will advise you on which one is right for your business and future goals. Although interest rates and fees are a significant part of any loan decision, choosing a lender who understands your business needs is just as important. After all, you will work with them for the next few years as you repay your loan.
At SouthEast Bank, we pride ourselves on our knowledgeable lenders, who are here to answer any question about the types of commercial real estate loans or any other investment opportunity you may be interested in. If you are interested in learning more about the commercial real estate loan we offer, contact us to set up a meeting.
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Information contained in this blog is for educational and informational purposes only. Nothing contained in this blog should be construed as legal or tax advice. An attorney or tax advisor should be consulted for advice on specific issues.