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What You Need to Know About Commercial Real Estate Loans

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Updated May 20, 2021
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What You Need to Know About Commercial Real Estate Loans; A commercial real estate loan can help you buy the property you need for your business.
If you own a small business during the COVID-19 pandemic, you know the challenge of managing cash flow, payroll, and other business expenses. Plus, you also understand the need to look out for the health and wellbeing of your staff and loved ones. Thankfully, given so many factors to consider, there’s help for small businesses. As part of the CARES Act passed by Congress, the Paycheck Protection Program was established, in addition to other supportive measures, to help small business owners successfully navigate these challenging times. When business owners need to purchase, refinance, or renovate commercial properties (as opposed to residential properties) they may seek out commercial real estate loans (CREs). The term “commercial” refers to the fact that the property produces income for the business. These properties can include, for example, offices, retail storefronts, or warehouses.Commercial real estate financing is commonly offered by banks, but it can also be secured through SBA loans or private investors. Whether you’re looking for a small commercial real estate loan or more substantial funding, make sure you understand your options, how they differ, and what types of commercial real estate lenders may offer them so you can secure a loan that aligns well with your business needs.  

Commercial Real Estate Loans Pros and Cons

How Do Commercial Real Estate Loans Work?

In contrast to a residential mortgage, which is a loan given to an  individual borrower, a commercial real estate loan is offered to a business entity. A business entity is an individual or group of individuals who form an organization to conduct a certain type of business and related activities. These entities can include:
  • S- and C-Corporations
  • Funds
  • Trusts
  • Limited partnership
  • Limited liability company (LLC)
There are a number of similarities between commercial real estate loans and residential mortgages. But there are also key differences to be aware of before you commit to a loan for commercial property. 

Collateral and Loan Guarantees

In many cases, the property itself acts as collateral for the loan (which may then be called a non-recourse loan). However, if a borrower doesn’t have good credit, a commercial real estate lender may require a loan guarantee, in which a third party with good credit acts as the responsible party if the loan goes into default. This provides the lender with an extra layer of security if the borrower can’t repay the loan. 

Eligibility Requirements

Commercial property loans are typically taken out for large purchases, just like home mortgages, but are often viewed as riskier. Thus lenders typically have stringent eligibility requirements to ensure that loan applicants will be able to pay back their loans. Most commercial real estate lenders are likely to have the following requirements:
  • The business must occupy at least 51% of the building being purchased
  • A minimum FICO SBSS score of 140 
  • A debt service coverage ratio (DSCR) of 1 or higher (typically between 1.25 and 1.5). The DSCR helps lenders determine whether you’ll be able to pay back your loan with the revenue made by your business. It’s calculated by dividing net operating income by total annual debt. If your DSCR is lower than 1, it’s an indication that your business income will not be sufficient to cover the cost of the loan. 
  • A strong personal credit history free of incidents like loan defaults, foreclosures, and tax liens. 
  • The property type must be commercial (not a single-family residence). Commercial properties may include:
    • Retail storefronts
    • Warehouses
    • Labs
    • Office space
    • Land for commercial development
The lender will also assess the property’s loan-to-value (LTV) ratio, which is the value of the loan compared to value of the property. Lenders typically set LTV at 65% to 75%, leaving the remainder for the borrower to put as a down payment for the loan. This is important to keep in mind, as you’ll need to know whether you can afford a down payment equal to 25% to 35% of the property’s value. 

Types of Commercial Real Estate Loans

The type of commercial real estate financing you might want to seek out depends on your business needs and eligibility. The different types may have different rates, terms, conditions, and purposes, depending on the lender. The common types of commercial real estate loans are:
  • Long-term commercial real estate loans: SBA and non-SBA Financing with longer terms that borrowers may seek out for projects with extended timelines.
  • Short-term commercial real estate loans: Financing with terms that can be anywhere from one year to five years. This category includes bridge loans, hard money loans, and mini-perm loans 

Long-Term Commercial Real Estate Loans

three types of commercial real estate loans: commercial mortgage, SBA 7(a), and SBA 504Long-term CRE loans are those with terms between five and 25 years and set repayment schedules, much like traditional home mortgages. Borrowers might seek out long-term loans for construction, land development, or property purchases.

Commercial Mortgage

What they are: Loans to make an investment in a commercial property for business use, which could include retail, warehouse, office space, or storage. These mortgages can also be used for land development as long as it’s for commercial use. Commercial real estate mortgages are most commonly offered by traditional banks, but can also be secured through government-backed lenders, life insurance companies, and hard money lenders.Why you might choose one: For many businesses, it’s helpful to operate out of a dedicated space, whether it’s used for welcoming customers or storing inventory. Investing in a commercial property is not only useful, but can give businesses equity to use in the future.Keep in mind: Since these types of loans often have longer terms and involve larger amounts of money, they are riskier for lenders. Therefore, the approval process can take longer and lenders may have stricter eligibility requirements than for other lending products.

SBA 7(a) CRE Loans

What they are: Offered through private commercial lenders, SBA 7(a) loans give small business owners funds they can use flexibly for a variety of purposes, including non-real estate needs. Why you might choose one: These loans give small business owners access to low-interest, fixed-rate commercial real estate loansKeep in mind: Lenders may have different eligibility requirements, but generally, SBA 7(a) loans are difficult to qualify for. Borrowers typically need good personal credit (650 or higher) and business revenues need to be strong (at least $100,000 annually). Additionally, down payments typically start around 10%, but can be higher based on the specific lender. 

SBA 504 CRE Loans

What they are: Financing for renovating commercial real estate or purchasing equipment to grow or expand your businesses. These commercial real estate loans provide long-term, fixed-rate financing to smaller, less-established businesses. They’re partially funded by certified development companies (CDCs), which are community-based nonprofits that help facilitate economic growth.Why you might choose one: In addition to lower interest rates and longer terms, 504 loans have lower down payment amounts (about 10%), making them a good option for smaller businesses that might not be eligible for financing elsewhere.  Keep in mind: SBA 504 loans are designed for specific business purchases and businesses may be required to show proof of how funding was used. You cannot use a 504 loan for working capital, inventory, or consolidating or repaying other debts.

Short-term Commercial Real Estate Loans

five types of short-term commercial real estate loans: bridge loans, mini-perm loans, hard money loans, construction loans, and land development loansFor borrowers who need commercial real estate financing more quickly or who don’t qualify for a long-term loan, a short-term loan may be a good option. 

Bridge Loans

What they are: As short-term commercial real estate loans, bridge loans have repayment terms typically ranging from six months to three years. A small business owner may turn to a bridge loan when it’s unable to obtain a longer-term commercial loan, needs to refinance a loan, or is waiting to secure another form of long-term financing.Why you might choose one: Bridge loans may help borrowers who need a short-term commercial real estate loan to cover smaller renovation costs they don’t want to refinance for, or if they don’t qualify for long-term loans. Bridge loans can also fill gaps in financing if you’re waiting for approval or funding from another commercial real estate loan option. Finally, the application and approval process are typically much faster than they would be with a traditional loan.Keep in mind: The convenience of bridge loans can cause them to be more expensive than other types of commercial property loans. Borrowers should be certain they are able to take on the cost of a short-term loan before committing.  

Construction Loans

What they are: Short- or long-term commercial construction financing for the purpose of building a new structure or renovating your current commercial property. Construction loans are typically offered by banks and credit unions, but can also be obtained through private investors via hard money loans. Why you might choose one: Many lenders have customized construction loan options that give borrowers flexibility with repayment and loan terms. Loans can cover the cost of materials, labor, and other construction-related expenses.Keep in mind: Lenders may require a down payment since a construction loan is considered higher risk. Down payments can range from 10% to 30% depending on the overall loan amount.

Land Development Loans

What they are: A type of commercial real estate loan for the purchase of undeveloped land. The land can be used by the business for further development and construction, or prepared for future sale.  Why you might choose one: If you’re a business owner who needs funding specifically for raw land, not the construction of a building. It can be used for improvements to the land, like infrastructure (sewer, water, electrical), or to create subdivisions for future use. Keep in mind: Lenders often have different requirements related to zoning, surveying, and land-use restrictions. Less developed land may increase borrowing costs compared to those for land that has already received some improvements.

Mini-Perm Loans

What they are: A short-term loan option (three to five years) to help pay off income-producing construction and/or commercial properties, or for the acquisition of an investment property. This form of commercial real estate financing is often used until a construction project is completed and longer-term options are available. Why you might choose one: A mini-perm loan can help a borrower cover the initial cost of a higher-risk project when the borrower doesn’t initially qualify for traditional commercial real estate financing. Mini-perms allow borrowers to establish payment history, which may also help them secure long-term loans in the future. Keep in mind: Because it’s riskier to lend to less-established businesses, lenders may charge higher interest rates. Additionally, mini-perm loans are obtained with the assumption that the property or investment will begin making a profit by the time the loan matures. If the project exceeds its original budget or timeline, that profit may be affected and it may be more difficult to pay back a mini-perm loan and maintain healthy business financials.

Hard Money Loans

What they are: Hard money loans are short-term commercial real estate loans that are based on the value of the property. Lenders are less concerned with the borrower’s credit rating and more concerned with the worth of the property, which acts as collateral for the loan. Why you might choose one: For borrowers who need funding quickly, who may not qualify for other types of CREs, or who have a lower credit rating, hard money loans may help. Because the application review process is based mostly on the value of the property itself, hard money loans tend to be faster and easier to acquire.Keep in mind: Private lenders are more likely to offer this kind of funding, but hard money loans typically come with higher down payments and interest rates than traditional loans. Because hard money loans are designed to be short-term options, high APRs (typically 10% and above) are the norm and may serve as an incentive to pay back the loans as quickly as possible.  

Commercial Real Estate Loan Amounts, Rates, Fees, and Terms

When you’re looking at how to finance a commercial property, it’s important to factor in the various rates, terms, and loan amounts available from different lenders. Below, you ‘ll find general information on commercial real estate loan amounts, rates, fees, and terms so you can ensure you’re choosing the right type of funding for your business and budget. 

CRE Loan Amounts

Loan amounts can vary depending on a few key factors:
  • Type of commercial real estate loan
  • Type of lender
  • Credit rating
  • Loan-to-value (LTV) ratio
  • Down payment amount
  • If the property is owner-occupied
The LTV is particularly important because it assesses the value of the loan against the value of the property. To calculate LTV, lenders divide the amount of the loan by the property’s appraisal value. The average LTV range for commercial real estate loans is between 65% and 75%.

CRE Interest Rates and Fees

It’s common for commercial real estate loans to have higher interest rates than a home mortgage, but they typically remain lower than other options. The National Association of Realtors (NAR) reported that in 2019 the average interest rate for commercial real estate loans was between 5% and 7%. SBA 504 loans may go as low as 4%, but rates will still depend on the borrowers qualifications and lender requirements. Additional fees may include:
  • Origination fees
  • Application fees
  • Closing costs
  • Appraisal fees
  • Prepayment penalties, if applicable

CRE Loan Terms

Commercial properties can be a significant investment, and it’s natural to question how long you can finance commercial real estate. Loan terms vary greatly, depending on the loan type and lender, but can range anywhere from a year for a short-term CRE loan to 25 years with an SBA loan.A major factor in understanding loan terms is amortization, or the lowering of the loan amount over time. Borrowers may be familiar with this term as it relates to a home mortgage or car loan, in which the amortization period and loan term are usually the same length. However, with commercial real estate loans, amortization periods typically exceed the length of the loan itself, meaning borrowers often need to make a large, final payment at the end of the loan term. For example, if a borrower takes out a five-year commercial loan with an amortization period of 30 years, he or she will make installment payments based on the loan being paid off over 30 years. After the five years, the borrower would then owe the remaining loan amount in full, in what is called a balloon payment. If you can’t afford to make the balloon payment in full, you may need to secure another form of financing. There are commercial real estate lenders that offer financing with full amortization, but you will need to research available lenders to find them. 

Applying for a Commercial Real Estate Loan

Applying for a commercial real estate loan requires careful preparation. You’ll want to look at various factors ranging from what the loan will be used for to how your eligibility will be assessed. Use the following steps as a guide when applying for commercial real estate financing.

1. Determine what the loan is for

You’ve decided to get a commercial loan, but what exactly is your commercial real estate loan best for? This is an important question since the answer may change the type of loan and lender you seek out. Here are a few factors to consider:
  • Is the loan for renovations?
  • Are you planning to build a new structure?
  • If you’re making a purchase, what type of property are you purchasing: land for development, retail space, offices, storage?
  • Do you need to pay for labor and materials?
  • What is your budget?
  • Do you have other sources of funding?

2. Choose the type of commercial real estate loan

After you determine what you’ll use the commercial loan for, you’re better prepared to research and choose a commercial real estate loan type. Some lenders offer specific types of commercial loans, which may limit how you can use the funds. A few examples of commercial loans are:
  • Construction loans
  • Commercial mortgage loans
  • Land development loans
  • Refinance loans
  • Hard money loans
  • SBA loans

3. Assess your qualifications

Each lender will have different eligibility requirements that may include:
  • Strong personal and business credit scores 
  • A debt service coverage ratio (DSCR) of 1 or higher
  • Down payment 
  • A loan-to-value ratio of 65% to 75%
  • Healthy business revenue
  • Approved property type for the type of loan you’re applying for

4. Find a lender

Take the information you’ve gathered about what you need the commercial loan for, what type of loan best aligns with your needs, and how you qualify for a commercial loan to search for lenders. As mentioned above, lenders could include banks, credit unions, and/or private lenders.

5. Prepare your loan application

Commercial real estate loans typically require significant documentation to show lenders that you’re a good candidate for the loan. While hard money loans may be faster to get and require  less documentation,  in general it will help to have the following ready when you apply:
  • Up to five years of tax returns
  • Business financial records for up to five years or since your business was established
  • Credit reports for business and all owners/partners
  • Cash flow projections
  • Business plan (to show the property’s intended use)
  • Identifying information (which may include citizenship)
  • Third-party property appraisal
  • Legal documents
Depending on the lender and loan type, the application and approval process can take some time, so it’s important to be patient.

Alternatives to Commercial Real Estate Loans

If you’re looking for additional financing options, the following alternative business loans may be helpful for your small business:

Restaurant Loans

Restaurant loans are used to help cover costs associated with starting or expanding a restaurant business. They are offered by various types of lenders, such as traditional banks, alternative lenders, and P2P lenders. 

Franchise Financing

A franchising loan can help with costs associated with opening a franchise location. Various lenders offer franchise loans, but there are also franchise companies, which specialize in them.  

Merchant Cash Advance

A merchant cash advance gives borrowers cash upfront with an agreement that the lender will take repayment as a percentage of the borrower's future credit card sales. Typically, automatic withdrawals are set up and taken directly from the borrower's bank account on a daily or weekly basis.

Invoice Factoring

Invoice factoring gives borrowers cash upfront in exchange for unpaid customer invoices. The factoring company (lender) is then responsible for collecting on unpaid invoices. 

Business Line of Credit 

A business line of credit is a common short-term loan option that many small business owners rely on to help maintain cash flow and cover smaller expenses. Borrowers receive a set credit limit from the lender and can draw money up to that maximum, paying interest only on the money withdrawn. 

Personal Loans

In some cases, taking out a personal loan to build commercial real estate or make other business-related purchases may be useful. If you don’t qualify for other types of business loan, you might consider a personal business loan.  

Lantern Credit Is Here to Help With Commercial Loans

There’s a lot to think about when it comes to how to finance a commercial property, but you don’t have to do it alone. As your source for small business financing, we’re here to provide you with the educational resources you need to make the right choice for your business.If you’re interested in comparing online small business lenders, we can help match you to loan products that align with your qualifications and needs. That can help you spend less time searching for financing and more time growing your business.
The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.SOLC20077

About the Author

Lantern

Lantern

Lantern is a product comparison site that makes it easy for individuals to shop for products and compare offers with top lenders. Lantern is owned and operated by SoFi Lending Corp., the digital personal finance company that has helped over one million people get their money right.
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