This article discusses:
- The basics of commercial real estate loans
- How commercial real estate loans work
- The terms of a commercial real estate loan
- Things commercial real estate lenders look for when loaning money
- Commercial real estate financing options
- Lessons real business owners have learned about commercial real estate loans
As a small business owner, there is a certain amount of pride in owning a brick and mortar from which to operate your company. But many entrepreneurs are shocked to discover that itâs not as easy as they thought it would be to get financing for commercial real estate.
Whether you have ambitions to become a real estate investor, or you just want to understand how to own your small businessâs real estate rather than having to lease a commercial building, here, youâll learn from real business owners about commercial real estate loans to help you jump-start the process. But first, hereâs a closer look at commercial real estate financing.
Commercial Real Estate Loans: The Basics
Commercial real estate loans (CREs) are mortgage loans that are typically used to purchase a commercial property or real estate.
To be designated as a commercial property, the real estate must be used for business purposes and produce income.
This includes office buildings, retail space, restaurants, medical office buildings, property loans, or any type of real estate investing or building from which you operate a business. CRE loans can also be used for refinancing business debt.
But commercial real estate mortgages cannot be used to purchase residential property unless the property will be used to generate income, such as in the case of multifamily housing or leased property.
How do commercial real estate loans work?
With a decent credit score, itâs relatively easy to get a commercial real estate loan when you choose the right lender.
Remain mindful that when you apply for a real estate loan, the loan will have to be made out to your business and not your individual name. This means that you have to form your company into a business entity, such as an LLC (limited liability company), limited partnership, or s-corporation.
There are various types of commercial real estate funding options available. But the main thing to keep in mind is that a lender will usually place a lien against the real estate youâre buying.
In other words, real estate property is used as collateral to guarantee the loan. If a borrower doesnât repay the loan as agreed, the lender can seize the property and revert ownership back to them.
What are the terms of a commercial real estate loan?
Commercial real estate loan terms can vary significantly from lender to lender. CRE loans usually have a loan-to-value (LTV) ratio of 65% to 80%. This means that if the purchase price of the real estate property youâre buying is valued at $200,000, the lender will loan up to $160,000 for you to buy the property, and you may have to come up with the rest as a down payment.
Depending on the lender, you will usually be allowed three to 20 years to pay off the loan. But this can be tricky with some lenders, as some commercial mortgage loans have extended amortization periods longer than the actual term of the loan.
Typically, amortization means that a loan is paid in monthly payments of interest and principal over the term of a loan. In the case of a commercial loan, your loan repayment terms might include 10-years of payments, but the payments are figured as though they are spread over 20 years.
Essentially this means you would have an outstanding balance known as a balloon payment that you will owe at the end of the repayment period. Not every type of commercial mortgage loan works this way, but many of them do, and itâs best to be fully aware and prepared so that you donât default at the end of the loan term.
Interest rates for a commercial real estate loan vary widely from lender to lender. On average, interest rates span from 3.5% to 12%. However, some CRE loans have higher interest rates, depending on varying factors, such as borrower creditworthiness and the terms of your loan.
Generally speaking, shorter repayment periods will have smaller interest rates charged to the loan, while longer repayment periods usually mean a higher interest rate for your CRE loan.
Most lenders also charge an origination fee of 0.5% to 1%. Youâll want to be aware of any prepayment penalties the lender might charge if you pay your loan off early. This typically comes to light when a small business owner refinances their business debt at more favorable terms.
What do commercial real estate lenders look for before loaning money to a business owner?
Commercial lenders will consider several factors before loaning money to a borrower. First, theyâll consider your credit history. Some lenders will have stricter requirements regarding credit, while others will have more relaxed underwriting rules.
In reviewing your credit records, youâll usually have to provide the last three to five years of tax returns and financial statements, including an income statement, balance sheet, and cash flow statement.
Some lenders will also consider a commercial propertyâs debt service coverage ratio or DSCR. They determine this metric by taking the property’s net operating income and dividing it by the debt service payments over a year.
For example, if you own a small apartment complex with a net operating income of $300,000 and your debt payments over a year equaled to $200,000, your DSCR would be 1.5. Many lenders are more likely to approve a commercial real estate loan if it has a DSCR of at least 1.25.
Some lenders will also scrutinize your debt-to-income ratio, but they are more likely to use that metric for residential mortgage loans rather than commercial mortgage loans.
Finally, the lender will look at the quality of the collateral in the event you default on the loan.
Commercial Real Estate Financing Options
As a small business owner, you have several real estate financing options available, but itâs important to find the one that works best for you.
A commercial real estate loan can finance an existing commercial property that you want to purchase or fund a new commercial construction project where you build your brick and mortar from the ground up.
You can also leverage a CRE loan to finance an income-producing property that you lease out to other small business owners or tenants.
Here are some of the more common ways to seek commercial real estate financing:
SBA 504 Loan
An SBA 504 loan program is backed by the U.S. Small Business Administration (SBA). This type of loan provides small business owners real estate financing with a maximum loan amount of up to $5 million. It is a long-term loan with a fixed interest rate through an SBA community-based partner known as a Certified Development Company.
SBA 7 Financing
An SBA 7 loan is another type of real estate loan that is backed by the SBA. Itâs easier to obtain than an SBA 504 loan, but itâs important to note that SBA loan application processes are notoriously lengthy. But if you are going to apply for SBA financing, this is the easiest of the two. Like the 504 program, the SBA 7 program will allow you to finance up to $5 million. You can use the loan proceeds to finance real estate, furnishings, supplies, equipment, fixtures, or working capital or to refinance your current business debt. SBA 7 interest rates are higher than a 504 loan but tend to work better for small business owners than a 504 loan. You can apply for an SBA 7 loan through an SBA-approved lender.
Traditional Banks and Credit Unions
Traditional lenders such as banks and credit unions are the traditional way of getting a commercial real estate loan. In recent years, they have toughened their lending standards and are harder to qualify for as they have the most rigid requirements regarding strong credit histories. As many borrowers have learned, their underwriting process, like that of the SBA, is exhaustive and typically takes longer than many small business owners would like.
Online Loan Providers
Online commercial real estate loans are growing in popularity as entrepreneurs seek more uncomplicated and streamlined ways to fund their ventures. For instance, Biz2Credit works with small business owners to help them access the best financing for their needs, whether for a commercial real estate loan, an equipment loan, a term loan, or a working capital loan.
Some online loan providers like Biz2Credit can also approve your commercial real estate loan faster than the SBA or a traditional lending institution. For instance, Biz2Credit will usually notify you of your loan status within a day, with your loan closing not far behind.
Hard Money Loan or Bridge Loan
Private investors sometimes seek financing through a hard money lender, who will usually loan money based on the value of the property rather than a borrowerâs creditworthiness. The problem with this type of loan is that itâs a high-interest short-term loan that doesnât allow much time to pay back the loan. Hard money borrowers tend to look at the loan as a way to get quick financing while continuing to negotiate for traditional financing to pay it off later. But the strategy sometimes backfires, and the borrower is left with some fairly difficult terms to meet on the loan.
Lessons Learned by Small Business Owners About Commercial Real Estate Loans
As you can imagine, many lessons are learned while negotiating business deals and seeking commercial mortgage loans. Here are some takeaways when it comes to commercial real estate loans.
Lesson #1: Look for a lender who can provide faster funding, so you donât miss your chance at a great opportunity.
Unfortunately, bank and SBA loans werenât created for business owners who want to begin building their company right away, as Dr. Ravindra Gautam of the Gautam Medical Wellness Center learned. Dr. Gautam and his physician-wife successfully built a small practice in their community. But at one point, they wanted to branch out and expand their practice by adding more physicians and satellite locations. Unfortunately, the California area where they practice has a shortage of available real estate, which means that they had to move fast to seize an opportunity when it became available. Their obstacle was that banks moved too slow, and any property the Gautumâs were interested in would be snapped up quickly by other interested parties who had access to faster funding. Luckily, the Gautumâs discovered Biz2Credit, who were able to fund their real estate purchase within 48 hours. The lesson here is that sometimes a business owner needs to leverage faster funding channels when it makes sense to do so.
Lesson #2: Itâs essential to develop a working relationship with a lender.
After owning and operating several restaurants and pizzerias over the past several years, Ray Anzola has learned that itâs important to have a lender by your side that is there with you every step of the way. Biz2Credit offered Ray a flexible financing plan so he could access more funds as needed for future projects, whether the need is for a real estate loan or a working capital loan. That way, he doesnât have to reapply for a business loan every time he needs money for his business. His latest focus has been spent on renovating his older restaurants. While renovation projects can take a great deal of time, Ray learned that when you have the funds you need for the job faster, everything else falls into place, and you can move more quickly to get things done. He advises other small business owners to get fast funding so that they have fewer disruptions in their businessâs operations.
Lesson #3: Not all online lenders are created equal.
Raza and David Bolos learned that the hard way when they searched for a lender to open their own kolache bakery in Colorado. They knew an online lender was the way to go as they would likely get their money faster. But as Raza proceeded with her search for the right lender, she noticed that interest rates varied. She also had questions, but many online lenders avoided answering those questions. Raza didnât feel validated or respected regarding the time she spent evaluating the best loan option for her and her husband. But when she discovered Biz2Credit, it was apparent they valued her time. She called Biz2Credit, and they guided her on the fastest process to get the funding needed for their bakery venture. Raza said Biz2Credit got her the financing she needed immediately. Her advice is to find an online loan provider you trust who will offer financing terms that you can manage. Raza and her husband have been so pleased with Biz2Credit that theyâve continued working with them when they needed other business loans.