How to Get the Best Deal on a Commercial Real Estate Loan
How to Get the Best Deal on a Commercial Real Estate Loan
If you're expanding or renovating your business, you're probably in a great place financially. However, just because you're in a period of growth, doesn't mean you should loosen your tight grip on the reins. There are many commercial financing options available, and it's crucial that you pick the best deal for your circumstances.
A commercial real estate loan is different from a residential loan. There are more options and often more stringent terms, higher rates and stricter rules, due to the increased risk for lenders.
Keep reading to find out about the various commercial real estate financing options, along with rates, eligibility, how to pick the best one and how to apply.
What Is Commercial Real Estate Financing?
Commercial property loans are used to refinance, construct, purchase or rehabilitate industrial, commercial or otherwise nonowner-occupied real estate. This could include any of the following:
- Hospitality venues, such as hotels, bars, restaurants, clubs and takeaway outlets
- Leisure centers
- Cinemas
- Education and community properties
- Shops
- Offices
- Manufacturing properties, such as warehouses and factories
- Care centers
- Fitness centers
- Medical facilities
- Multiunit rental buildings
- Vacant land purchased with the intention of building these types of property
- Vacant land for the development of family homes
Commercial property secures the commercial real estate loan, unlike residential mortgages, where the underlying asset is a primary residence. Commercial lenders underwrite income generated by the property. There's no one-size-fits-all when it comes to commercial property financing. With plenty of research and thorough investigation, you'll find the best loan option for your needs.
Pros
Let's break down the main differences between commercial and residential real estate loans.
Commercial Real Estate Loans
- Loan-to-value ratios tend to be between 65% and 85%.
- Commercial mortgages tend to be signed off for business entities, such as developers, corporations, funds, trusts and partnerships.
- The amortization period is longer than the loan itself, typically ranging from five to 20 years.
Residential Property Loans
- Very high loan-to-value ratios are permitted, sometimes as much as 100%.
- Residential mortgages are usually signed off for individuals or couples.
- Residential property loans are amortized, with the most popular product being a 30-year fixed mortgage.
Different Types of Commercial Real Estate Loans
There are many types of commercial real estate loans and rates available. The following is an explanation of the different types of business loans that owners and developers can use to purchase profit-making real estate.
Conventional Commercial Mortgage
The name of this type of commercial property loan is self-explanatory, and it's the first thing many people consider when shopping for this type of financing. You can use this type of loan to buy properties as investments or business space. These are the most similar to a typical mortgage loan and are available from traditional lenders, such as banks.
Terms tend to fall between five and 30 years, with a minimum down payment of up to 25% and low-interest rates. While this is often the most desirable option, it's also usually the hardest to qualify for.
Business Line of Credit
A business line of credit is more akin to a credit card than a traditional loan, with a maximum credit amount instead of a lump sum payment. You can take funds out of your account as required, and you only pay interest on the money you spend.
This type of financing is most appropriate for business operators who are renovating a commercial property.
Commercial Construction Loan
A commercial construction loan applies to a building that hasn't yet been built. If you're looking to buy a piece of land and start your business from scratch, this could be the ideal choice.
SBA Real Estate Loans
The U.S. Small Business Administration offers guarantees for some types of commercial property loans. Real estate investors are not eligible for this form of financing, but business owners have two options to choose from:
- SBA 7(a) Loans: This is a more flexible option that can be used for working capital and purchasing equipment, in addition to real estate. A single commercial lender provides this type of loan, with as much as 85% guaranteed by the SBA. You might be able to make a down payment as low as 10%, but this can be higher depending on your circumstances.
- SBA 504 Loans: This type of loan is exclusively for purchasing commercial property and equipment or for the renovation or refinancing of an eligible commercial construction or real estate loan. It's provided by a combination of two lenders; a certified development company provides 40%, and a private commercial lender covers 50%. Generally speaking, you'd put up the remaining 10% as a down payment, although this percentage can vary.
Bridge Loan
Bridge loans are short-term commercial real estate financing options, with terms usually falling between six months and three years. It's called a bridge loan because it's usually utilized by business owners who are in the application stages for long-term loans, which can take a long time to qualify for.
You're more likely to get this type of loan from an alternative lender than a credit union or bank. They're also used by real estate investors who flip homes for profit.
Hard Money Loan or Soft Money Loan
Hard and soft money loans are shorter-term loans than traditional commercial mortgages, but they're easier to qualify for and faster to clear. As a caveat, they also tend to have higher loan rates and shorter repayment terms. Let's look at the differences between the two:
- Hard money loan: This is similar to a bridge loan, but it usually comes from a private lender. Down payments and interest rates are typically high, and terms are short.
- Soft money loan: This is a hybrid between a traditional commercial loan and a hard money loan. You need to have a strong credit history to qualify, but you can get lower interest rates than with hard money loans.
Commercial Real Estate Loan Rates
Now that you know about the different types of commercial property loans, let's break down how they work with regard to repayment.
Repayment Terms
While residential mortgages come in two straightforward varieties: 15-year terms and 30-year terms, there's more flexibility when it comes to commercial real estate loan terms.
Bank loans and SBA loans are typically amortized commercial mortgages with 20- to 25- year terms. Payments are made in monthly installments, and initial payments pay off the interest. Subsequent payments go toward paying off the balance of the loan.
Hard and soft money loans have much shorter terms, ranging from six months to five years. This means they're best suited to flipping properties or as renovation or construction loans if you're not eligible for traditional commercial real estate financing.
Balloon Payments
Balloon payments are something else to consider for business owners who are confident their business is going to succeed. This repayment schedule is usually set between five and seven years, with interest-only payments made month to month and the final balance due in a lump sum balloon payment at the end of the loan term.
Keep in mind that if you can't afford that final repayment, you might need to sell your commercial property entirely or refinance your business mortgage.
Amounts
The maximum loan amount you can access from a commercial property lender depends on two key factors:
- The type of lender you work with
- The purchase price of the commercial real estate
After-Repair Value
For a renovation project, lenders write loans based on the ARV, which is the approximate value of the property once repairs are complete. Short-term lenders usually offer up to 70% ARV.
Loan-to-Value
LTV describes the size of your business property loan in relation to the purchase price of the commercial real estate. Banks often go up to a 90% LTV ratio, while a short-term lender wouldn't usually go above 60%. You'll need to cover the remaining balance that isn't covered by the loan, and the higher your down payment, the lower your interest rate is likely to be.
Fees
Lenders usually charge application fees, origination fees and property appraisal fees. There might also be prepayment fees, which is a penalty applied if you decide to pay your loan off early. It's important to read the small print of your loan agreement, and pay close attention to the various types of fees when you're comparing commercial property financing options.
Interest Rates
Commercial real estate loan rates vary considerably depending on factors, such as your business type, its financial health and your personal credit score. You should expect somewhat higher rates than a residential mortgage because lenders have to take more risk.
That said, because the real estate is collateral, commercial real estate loans are often cheaper than other types of business financing. Banks tend to have the most appealing rates, sometimes as low as 5%, but they're harder to qualify for. Short-term lenders might charge up to 30%, but they're easier to qualify for and faster to process.
Who's Eligible for a Commercial Mortgage?
The main factors lenders consider when you apply for a commercial real estate loan include:
- Creditworthiness: Credit score is a major consideration for lenders because it lets them know how likely you are to make payments on time based on your credit history. Most lenders expect a credit score higher than 580, but you'll get the best deal on a commercial mortgage if your score is higher than 700.
- Real estate collateral: Commercial property loans are asset-dependent, so the lender has the rights to your real estate if you can't make repayments.
- Debt service coverage ratio: DCSR is your annual net income divided by your annual loan repayments. This measures how much cash your business has available to meet repayment terms and signals to lenders that you're able to comfortably pay off the loan.
Time in business: Similar to having a longer credit history, more time in business gives lenders confidence that you're less of a risk. Many businesses fail within the first five years, so a younger business is more of a risk than an established one that's proven its profitability over time.
Choosing the Right Commercial Real Estate Loan for Your Business
Here are some tips to help you choose the best deal on a business property loan:
- Consider how quickly you need funds available to make your purchase or renovation. If you're going up against a buyer that has the full amount available in cash, a traditional commercial mortgage or SBA loan can take too long to clear. In this case, you might consider a hard money loan or bridge loan.
- Be realistic about what's available to you in your current circumstances. If you have an excellent credit score, you've been in business a long time and you've got time to apply, it goes without saying that you should choose the most affordable option. This is usually a traditional bank loan.
- Beware of falling for the first sales pitch you hear from a lender. Hold off and shop around extensively to make sure you're not only getting the best APR and interest rates, but that you're also not going to get hit by fees and charges hidden in the small print of the loan terms.
Let Lendzi Do the Hard Work for You
Shopping around for a commercial property loan can be time-consuming and challenging when you have a business to run. Get in touch with Lendzi today, and we'll help you find the best deal for your company.
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