Commercial Lending Basics
The best commercial lending basics offer more than just the opportunity to build professional relationships and avoid tenancy problems that often occur with residential rental properties. It also offers lucrative income potential, which can be far superior to traditional real estate investing. As any commercial realty investor will tell you, it’s not always about finding commercial properties. It is more about acquiring those essential commercial realty loans that allow you to add a property to your portfolio.
Although many lending principles are the same for residential and commercial real property loans, there are some important distinctions and tricks-of-the trade that you should know about commercial real estate loans. Understanding them before you start can help save time and money.
COMMERCIAL LENDING BASICS: REAL-ESTATE
Like their single-family counterparts in the commercial property loan category, they are the cornerstone of any great real estate investment. The loans are as important as the assets, if not more. There are many commercial real estate loans that offer unique benefits to investors who know how to use them. Investors shouldn’t just take any loan that is offered to them. They need to do their research and learn all the details of commercial real estate loans before they make any decisions. Investors will benefit from knowing more about their CRE loan and how it applies in their particular situation.
Entities Vs. Individuals
Residential loans are often made to individuals. Commercial real estate loans are typically made to businesses. Also known as business entities, entities are a variety of businesses. They can be developers, corporations, funds, trusts, limited partnerships, or investors. These entities are often eligible for commercial real estate loans. Receiving a commercial loan might be the reason the entity was established in the first place
An entity will not have a credit rating, unlike a residential loan in which money is granted to borrowers on the basis of their credit score. Instead, the entity will be able to have its owners guarantee the loan. The entity’s owners will then provide credit history. The owners will give the lender an indication of who to contact in the event of default.
Here are some common questions about commercial realty lending.
What is a COMMERCIAL REAL ESTATE LOAN?
A commercial realty loan or “CRE Loan” is a debt-based agreement between a borrower (or financial institution) that allows the borrower to use funds to purchase commercial (nonresidential) property.
A common misconception is that “commercial loan” can be interchangeable with “commercial realty loan”. This is incorrect. Commercial loans are used to secure funds that can be used for non-realty purposes such as for equipment purchases or operating costs. You are looking for lenders that specialize in commercial real estate loans as an investor.
Types Of Commercial Real Estate Loans
Commercial real estate loans are available with many terms and underwritings. Buyers can find deals at favorable rates and terms due to the large number of commercial real estate loans available. Practically every scenario a commercial realty investor could imagine is covered by a loan. Let’s take an in-depth look at the most sought after commercial real estate loans of today:
- SBA7(a) Loan for Commercial Real Estate: The U.S. Small Business Administration backs SBA 7 (a) loans. There are many types of SBA loans. This one is for those who wish to buy or refinance commercial properties up to $5,000,000.
- CDC / SBA504 Loan for Commercial Real Estate: The U.S. Small Business Administration also backs CDC / SBA504 loans. CDC / SBA 504 loans are best suited to those who require more than the $5,000,000 SBA 7(a) loans offer.
- Traditional Commercial mortgage: Traditional commercial mortgages are available through institutionalized banks or lenders. Although traditional loans are typically five to twenty years in duration, they are excellent for people with good credit who need longer loans.
- Commercial Bridge Loan: Business bridge loans allow investors to obtain immediate financing. This gives them the opportunity to look for a longer-term solution. Investors can bridge the gap between when they require immediate financing and when they are able to find a permanent solution. Bridge loans allow them to do this.
- Short-term Loans: These loans are for people who have a short-term loan need. These loans have higher interest rates but come with the benefit of lower monthly payments. Hard money lenders don’t have to be associated with an institutionalized bank. This means that borrowers can get the money quickly and without having to have perfect credit.
HOW LONG DO COMMERCIAL REAL-ESTATE LOANS LASTEN?
A commercial real estate loan can last as long as 30 years or as little as a few months. They will typically have terms of between 5 and 30 years.
However, this does not mean that you will have to pay a monthly commercial mortgage throughout the term. Contrary to residential loans which are fully amortized (or the balance is broken up into regular monthly payments), commercial real estate loans typically have a fixed monthly payment period (usually for the first five to seven year) and then require a large lump sum at the end.
This could be a boon or a disaster for commercial realty investors. You should do your research to ensure that the terms of any commercial real estate loan are compatible with your real estate investing goals.
Schedule for CRE Loan Repayment
A commercial real estate loan repayment plan can range from five to twenty years. Although there are exceptions, this seems to be an industry norm. The amortization period of commercial real estate loans is typically longer than the loan. A commercial real estate loan’s interest rate can change depending upon its length and amortization. This is similar to a residential loan. Investors with good credit may be able to negotiate more than those without.
WHAT ARE COMMERCIAL REAL ESTATE LOAN REQUIREMENTS
No matter the type of loan you are applying for, there are certain criteria that all lenders must follow. These are the key requirements for a CRE loan.
- Credit History: This has less to do with credit scores (which should be at least 680) and more to do about ensuring that your credit history does not include recent tax liens or foreclosures. The commercial real estate loan process can be difficult if you don’t have this information.
- Low Loan-To Value (LTV): Ratio The LTV Ratio calculates how much equity or collateral a borrower has in property by dividing loan amount by appraised value (or purchase cost) of property. Example: Your LTV for a loan amount of $97,000 and a property worth $100,000 is 97%. LTV for home buyers who secure a residential loan may reach 100%. However, it is more common to see an LTV in the 80-97% range. A commercial real estate loan for investors will require a minimum of 65-80%.
- Business Entity: This is the most common mistake first-time investors in commercial real estate make when applying for a loan. Sometimes, it can make a big difference to lenders if your business entity is set up before you submit the application.
- Organized Paperwork: This area is often overlooked by first-time investors. It can make a difference in whether you get rejected or receive the large commercial real-estate loan that you want.
- Online Marketplace loan: Also known as a “soft-money” loan, an internet marketplace loan matches borrowers with private investors that help to finance commercial properties in return. These loans are often referred to as a “soft loan” because they have an interest rate that is comparable to hard money lenders and conventional banks. These loans are typically short-term for commercial real property, and can last anywhere from six months to several years.
- Joint Venture loan: If a single entity cannot secure a loan for itself, it may join forces with another entity. Joint venture loans are available to entities that seek them. The loan is given based on two entities, rather than one. This makes it more attractive for entities that would otherwise be unable to qualify.
Are CRE loans subject to fixed or variable interest rates?
It all depends on what type of commercial real property loan you have. There are many types of CRE loans available, including traditional commercial mortgages, bridge loans, hard money loans and joint venture loans.
A commercial real estate loan will almost always have a variable interest rate. This is because the large amount of money borrowed has a cost and can be significantly higher than residential loans (sometimes up to two or three percentage points).
CAN YOU GET A COMMERCIAL REAL ESTATE LOAN WITH NO MONEY DOWN?
You can get a commercial realty loan without having to put down any money. It is important to remember that the more money an entity puts down, however, the easier it will be for them to qualify. A down payment is not required; there are many other financing options.
If an entity is unable to raise the funds, they might partner with another entity to form a joint venture. The other entity could then take over the financing. A bridge loan is another way to avoid having to put down any of your own cash. Investors can get short-term financing for a down payment with bridge loans. This allows them to negotiate a longer-term loan from a traditional lender.
HOW LONG IS IT GOING TO TAKE FOR A COMMERCIAL REAL ESTATE LOAN TO GET?
It takes about 3 months for a commercial loan to be approved. It may take longer than that. If your lender or broker is honest, they will tell if you are willing to wait 45-120 days.
There may be instances where you can reduce the commercial loan process. If your investment strategy is dependent on a fast timeline, you might need to be flexible while waiting for a response from a lending institution.
Calculating COMMERCIAL REAL ESTATE LOANS
Once a set of metrics is available, a calculation can be done. To calculate a commercial realty loan, an entity must first determine the loan amount, interest rate and amortization term. If applicable, any balloon payments will also need to be obtained. Once you have all the numbers, go to an online mortgage calculator and complete the fields.
HOW TO CALCULATE LOAN-TO-VALUE RATIO
A loan-to-value ratio, as the name implies, allows entities to compare the loan’s value against the property’s value. To calculate the loan to value ratio (or simply LTV), divide the amount of the loan by the property’s appraisal or purchase price. Use whichever is lower.
Although it is not as difficult as people think, understanding today’s commercial lending basics requires far more preparation, patience, diligence, paperwork, and preparation than a residential mortgage loan. This is due to the large amount of funds involved. Commercial real estate financing can be more complex and logistically difficult than residential mortgage loans. This is due to the higher risk. There are many moving pieces, both legal and financial. If you are persistent and focused throughout the process, you may find a life-changing deal.