If you’re seeking small business loans specifically for purchasing commercial real estate, whether that’s a multifamily unit you plan on leasing out or commercial office buildings, there are commercial real estate loans to consider.
What is Commercial Real Estate Loans?
A commercial real estate loan is a lending product from a bank or other financial institution used to purchase, build, or renovate a commercial property. While most people associate commercial real estate loans with investing in commercial real estate, the uses for these loans are actually more specific than that. Commercial real estate loans are designed to finance the purchase or improvement of property that is being used for your own business.
To get a commercial loan, you need to use a majority of the property securing the loan for your own business purposes. This means that you can still lease out part of the underlying property, but at least 51% of the property needs to be used for your business.
IMPORTANT LOAN RATIOS TO NOTE
These ratios define and determine your financing rates and loan size.
Loan-to-Value Ratio: This is the ratio that makes sure that the collateral (a piece of commercial property) is worth materially more than the amount of the loan.
The (LTV) equals the amount of the commercial mortgage divided by the market value of the property as determined by a commercial appraisal. Typically, Loan-To-Value-Ratios for commercial real estate loans are capped at 75% or 80%.
Debt service coverage ratio: The DSCR measures the ability of a company to use its operating income to repay all its debt obligations. Debt service coverage ratio, or DSCR, measures the ability of a company to use its operating income to repay all its debt obligations. In other words, the DSCR indicates how easily a company can meet its debt obligations using its net operating income (NOI).
The DSCR equals annual net operating income divided by annual debt service. Net operating income is the gross rental income minus expenses. Most commercial lenders require a minimum DSCR of 1.25x.
TYPES OF COMMERCIAL REAL ESTATE LOANS
1. SBA 7A Loan:
Small Business Administration SBA 7A loans are a good choice for a commercial real estate loan due to their low rates. With an SBA 7A loan, you can get financing of up to $5 million for up to 25 years. These loans are ideal long term loans for buy and hold investors. The SBA 7(a) loan program is more general in nature, and business owners have a lot of flexibility in how they can use the funds.
2. SBA 504 Loan
With the SBA 504 program, small business owners must use the funds to finance the purchase of commercial real estate or machinery and equipment.
SBA 504 loans are provided through two lenders: a private commercial lender (a bank or traditional lender), which provides 50% of the project costs, and a Certified Development Company, which provides 40%, all of which is guaranteed by the SBA. You provide the remaining 10% as a down payment, making this a low down payment option for real estate investors.
3. Conventional Bank Loan:
A conventional commercial mortgage loan is issued by banks who lend to credible entities. It can be used to purchase or refinance real estate, such as owner-occupied office buildings, retail centers, shopping centers, industrial warehouses, and other commercial properties.
Because these loans can be large and aren’t government-guaranteed, the required qualifications are stricter. A minimum credit score of 660 is needed. The larger the loan requested, the more stringent the financial and credit requirements will likely be.
4. Hard Money Loan:
Hard money loans often known as “bridge” loans are short-term commercial real estate loans with repayment terms ranging from one to four years. Hard money loans are typically used by businesses that cannot get funding from other traditional lenders either due to credit issues or properties in disrepair.
They are considered last resort mortgage financing due to high interest rates and fees. One advantage of hard money lenders is rapid funding times, with loans funding in a matter of days. However, fees can be very high.
5. Online Marketplace Loan:
Online Marketplace Loans are often called “soft money” loans. It allows borrowers to access money, for real estate projects, from accredited investors. Borrowers pay monthly interest on real estate loans, and investors get the share of those payments as they are received. It enables investors to review investment on its own merits before making an investment decision. The duration of these loans usually lasts from six months to a few years.
6. Joint Venture Loan:
A joint venture is an agreement by two or more people or entities in the event a single entity isn’t able to secure a loan by itself, it can join forces with another entity. By seeking a joint venture loan, the loan will be given out based on two entities instead of one, effectively making them partners, but also making it easier for entities who would otherwise not qualify.
Interest Rates and Fees for Commercial Real Estate Loans
Commercial real estate loans typically have higher interest rates than mortgage loans, with an average rate of 5 to 11%. Some lenders may go lower than that range, however, depending on the loan type and structure and the financials of the business. For small businesses that qualify, for example, SBA 504 loans typically provide lower commercial real estate loan rates, with averages below 3%.
Where a commercial real estate loan can get really costly is with prepayment penalties and fees. As you compare lenders, make sure to read the fine print to determine how much you might be charged if you choose to pay off your debt early.
How to Get a Commercial Real Estate Loan
Each type of commercial loan will have a slightly different process for applying and getting approved. Spend time looking at requirements to make sure you have all the necessary paperwork to strengthen your application.
How to Prepare for a Commercial Real Estate Loan
Once you’ve reviewed the requirements for the loan you’re planning to apply for, spend some time gathering everything you’ll need in advance of applying. The more prepared you are, the easier the application process will go.
If you know your credit scores won’t qualify you for the best rates, you might consider building your credit before applying. You can do this by paying down other debt, making your loan payments on time, and monitoring your credit report regularly.
Also, before applying, get a plan for how you will be able to pay the loan back. If you take on too much debt and aren’t able to make your monthly payments, the real estate you’re buying could be seized by the bank or lender.
As informed investors we should understand the risks associated with real estate investing and that there is no guarantee. Please do your due diligence.
What are the requirements to qualify for a commercial real estate loan?
To qualify for a commercial real estate loan, borrowers generally need to have a strong credit history, a solid financial plan, and a solid business plan. The lender will also consider the value of the property being purchased or refinanced, as well as the borrower’s ability to make regular payments on the loan.
How much can I borrow with a commercial real estate loan?
The amount you can borrow with a commercial real estate loan depends on a number of factors, including the value of the property, the type of property, and your financial situation. Lenders will typically consider the loan-to-value ratio (LTV) when determining how much to lend. The LTV is calculated by dividing the loan amount by the value of the property.
What should I consider when choosing a commercial real estate loan?
When choosing a commercial real estate loan, it’s important to consider the interest rate, fees, loan term, and repayment schedule. You should also think about the lender’s experience in commercial real estate financing and their customer service. It’s important to choose a loan that meets your financial needs and goals while also fitting within your budget.
