- What Is a Commercial Real Estate Loan?
- Types of Commercial Real Estate Loans to Consider
- Conventional Bank Loans
- SBA Loans
- Bridge Loans
- Hard Money Loans
- Where to Find CRE Loans: Types of Lenders
- Private Lenders
- Credit Unions
- Conduit Lenders
- Peer-to-Peer Lenders
- What Lenders Consider Before Underwriting a Commercial Real Estate Loan
- 1. The 5 Cs of Credit
- 2. The Purpose of the Loan
- 3. Your Income and Expenses
- 4. Documents to Prepare for a Commercial Real Estate Loan Application
- Final Thoughts
- Get Financing
What Is a Commercial Real Estate Loan?
Commercial real estate loans are used for financing the acquisition, construction, repositioning, or refinancing of a commercial property, such as office buildings, retail centers, warehouses, and hotels, as opposed to residential properties. Commercial real estate is usually defined as any income-producing property that is used for business purposes. CRE differs from residential real estate in several key ways, which is why commercial real estate loans are also different.
The most significant difference between CRE and residential loans is the loan amount. Residential loans are typically much smaller because they are meant to finance a single-family home. The average residential loan hovers around $280,000 while the average CRE loan is usually around $2 million. This is because commercial properties tend to be much larger and more expensive than residential properties.
Loan terms also differ for residential and commercial mortgages. While residential mortgages are typically permanent, longer-term fixed-rate loans, commercial loans are often shorter, 5-10 years, can be amortized over a 25-year term, and might come with a large balloon payment at the end of the loan.
Types of Commercial Real Estate Loans to Consider
Conventional Bank Loans
Bank loans are the most common type of financing for commercial real estate properties. They can be used for a variety of purposes, including the acquisition, development, or refinancing of an existing property.
Loan terms usually vary from one lender to another, however, most banks offer competitive rates and don’t require the property to be owner-occupied. Nonetheless, conventional bank loans are typically harder to qualify for due to stricter underwriting requirements. Banks commonly finance mid-to-large-sized projects and require a credit score of at least 660 and a 20% downpayment. Bank loans also carry prepayment penalties, such as yield maintenance, step-down prepayment, or defeasance.
The Small Business Administration (SBA) offers two main programs that can be used to finance commercial real estate investments: the SBA 7(a) program and the SBA 504 program.
The SBA 7(a) program can be used for a variety of purposes, including the purchase of a commercial real estate property, business, equipment, fixtures, or refinancing debt. The maximum loan amount that can be borrowed through this program is $5 million, however business owners can also opt for smaller amounts that banks are not willing to lend. Down payments are typically 10%.
If you don’t qualify for a conventional loan, the SBA 504 loan program might also be a right fit for you. The loan can be used for financing the expansion or renovation of existing properties, or for refinancing a real estate property. To qualify for an SBA 504 loan, borrowers must again have good credit and be able to put down 10% as a down payment. The maximum loan amount that can be borrowed through this program is $5 million.
One benefit of both SBA 7(a) and 504 loans is that they offer longer repayment terms, which can make them more affordable for borrowers who might not otherwise qualify for a traditional bank loan. SBA loans are also attractive because they often come with relatively low-interest rates. However, borrowers should be aware that these loans do tend to take longer to close than other types of loans — in some cases taking up to 90 days or more from application to funding.
Bridge loans are typically short-term loans that are used to finance the purchase of a commercial property prior to securing long-term financing. These loans are usually interest-only loans with terms lasting anywhere from 6 months to 3 years. As bridge loans are meant to be short-term financing solutions, they often come with relatively high-interest rates.
Bridge loans can be helpful for investors in need of quick financing in order to take advantage of a particular opportunity but who might not yet qualify for more traditional forms of financing. For example, let's say an investor finds a great deal on a fixer-upper but needs $200,000 in order to repair and renovate the property before taking out a long-term mortgage or refinancing the property once it has been remodeled. In this case, taking out a bridge loan could make sense because it would provide the investor with the capital they need upfront while allowing them time later on down the road when they may have more equity in the property or may otherwise qualify for more traditional forms of financing.
Hard Money Loans
Hard money loans are another type of short-term financing solution that can be used by investors when traditional forms of financing are not an option — usually due within 1-3 years. Hard money lenders tend to focus more on the value of the property being purchased than on the borrower's credit history or ability to pay back the loan.
As such hard money loans can often be easier to obtain than other types of financing, hard money loans also tend to come with relatively high interest rates and origination fees. Hard money loans should usually only be considered as a last resort when other forms of traditional financing are not possible. But when used correctly, hard money loans can provide investors with much-needed capital in order complete deals quickly which might otherwise fall through.
Where to Find CRE Loans: Types of Lenders
As mentioned above, banks are conventional or traditional lenders of commercial real estate loans. Banks usually have strict eligibility requirements and mostly finance low-risk projects. Banks also require a large down payment, however, also offer some of the lowest interest rates.
Private lenders are individuals or companies that lend money to commercial real estate investors. Private lenders are less stringent compared to banks, and the underwriting process usually depends on the purpose of the loan and the type of investment. Private lenders provide more flexible and customized terms, however, interest rates are higher compared to bank loans.
Credit unions typically have more relaxed eligibility requirements than banks and often offer lower interest rates. However, credit unions usually only finance low-risk projects because they need to generate enough income to cover their operating expenses.
Conduit lenders are large financial institutions that securitize CRE loans into commercial mortgage-backed securities (CMBS). Conduit lenders often offer lower interest rates than banks and other types of lenders because they can spread the risk associated with the loan across multiple investors through the CMBS market.
Peer-to-peer lending platforms are online platforms that connect borrowers with individual investors who are willing to fund loans. Peer-to-peer lending platforms typically finance lower-quality projects because they rely on crowdsourcing to raise capital.
What Lenders Consider Before Underwriting a Commercial Real Estate Loan
1. The 5 Cs of Credit
The first thing lenders will consider is your credit history. They will likely look at your credit score and your payment history on other loans or lines of credit. Lenders will also consider your current level of debt, as well as your capacity to take on more debt. In addition, they will take a close look at the collateral you have to offer and your character — whether or not they think you’re likely to repay the loan. This is often referred to as the 5 Cs of credit.
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2. The Purpose of the Loan
Another important factor that lenders will consider is the purpose of the loan. For example, is the loan for the acquisition of a property? If so, they will want to see evidence that you have a solid plan in place for how you intend to use the property and generate income from it. Lenders will want to see proof that you have the financial resources in place to make a down payment and cover closing costs. In either case, having a well-thought-out business plan is crucial.
3. Your Income and Expenses
Lenders will also want to get an idea of your income and expenses — basically, they’ll want to know if you have enough money coming in to make loan payments on time and in full. To do this, they’ll likely request tax returns and bank statements. They may also ask for documentation of any other assets or liabilities you have. Being able to show that you have a healthy cash flow is crucial when qualifying for a commercial real estate loan.
4. Documents to Prepare for a Commercial Real Estate Loan Application
Business tax returns
Information on collateral
A third-party appraisal of the investment property
Business plan and strategy
Applying for a commercial real estate loan can be intimidating, and there are no shortcuts to it, therefore it is important to fully understand the process and have the right tools to obtain a loan. Our team at Commercial Real Estate Loans can help you find the best financing option for your deal — fill out the form below to connect with us, and an advisor will get in touch with you. Until then, check out our Commercial Mortgage Calculator to get a better picture of your CRE financing scenario.