If you're looking to purchase commercial real estate for your small business, whether it's a multi-family unit or an office building, you'll need to explore your options for commercial real estate loans. These loans are specifically designed to help borrowers acquire new commercial properties, renovate existing properties, or refinance real estate debt. Let's dive deeper into the world of commercial real estate loans and discover how they can benefit your business.
What are Commercial Real Estate Loans?
Commercial real estate loans are financial products that enable borrowers to purchase, renovate, or refinance commercial properties. These loans open up opportunities for small business owners to invest in properties that they might not be able to afford otherwise. These properties are often used for business purposes, such as office spaces or multi-family units that can be leased to tenants for a profit. By leveraging commercial real estate loans, investors and developers can expand their portfolios and increase the number of viable commercial properties on the market.
How Do Commercial Real Estate Loans Work?
While commercial real estate loans share similarities with traditional mortgage loans, there are some key differences that small business owners should be aware of.
Loan-to-Value Ratio
The loan-to-value ratio (LTV) is a crucial metric that lenders use to determine the amount of money they can lend. LTV is calculated by dividing the loan amount by the property's value. Typically, lenders prefer an LTV of around 75% to 80% for commercial real estate loans. This means that you either need to find an undervalued property or have a down payment of 20% to 25% before approaching a lender. However, it's important to note that not all lenders strictly rely on LTV for determining loan amounts. Some may also use the debt service coverage ratio (DSCR).
Personal Guarantee vs. Non-Recourse Loans
When obtaining a commercial real estate loan, the property itself serves as collateral. However, in some cases, lenders may also require a personal guarantee. This means that if your business fails to repay the debt, you, as the borrower, will be personally liable for making the payments. On the other hand, some lenders offer non-recourse loans, where the property itself is the sole means of recovering the loan funds. In this case, if the property cannot cover the outstanding balance, the lender cannot seek additional payment from the borrower.
Types of Commercial Real Estate Loans
There are several types of commercial real estate loans available, each catering to different business needs and qualifications. Here are six primary types of commercial lending that you can consider:
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Permanent loans: These loans are similar to traditional mortgage loans and are typically obtained from commercial lenders. They have an amortization schedule and a repayment term of five years or more.
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SBA loans: The U.S. Small Business Administration provides guarantees for some commercial real estate loans. SBA 7(a) loans offer flexibility in fund utilization, including non-real estate financing needs. SBA 504 loans are specifically designed for financing commercial real estate or machinery and equipment.
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Bridge loans: These short-term loans bridge the gap between long-term financing or refinancing options. They are ideal for small business owners waiting for more favorable loan terms or real estate investors aiming to fix and flip properties.
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Lines of credit: Similar to personal or business credit cards, lines of credit provide access to funds up to a certain limit. This option is suitable for businesses undertaking commercial property renovations or those needing immediate cash flow.
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Hard money loans: These financing solutions, typically provided by private companies and individuals, are used by real estate investors for short-term projects. Hard money loans have a loan term ranging from three to 36 months.
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Owner financing: In this arrangement, real estate investors and even homebuyers purchase properties directly from sellers without obtaining a mortgage loan. Owner financing offers less strict eligibility requirements, making it an alternative for those with lower credit scores or self-employed individuals.
Pros and Cons of Commercial Real Estate Loans
As with any financial solution, commercial real estate loans have their advantages and disadvantages. Let's take a closer look at both:
Pros:
- Many options available, including different loan types and repayment terms.
- Flexible repayment terms that align with your business's schedule and budget.
- Tax breaks and appreciation of property value.
- Diverse property types available for purchase, including multi-family apartments, retail spaces, office spaces, and single-family homes.
Cons:
- High barrier to entry with strict qualification requirements and approval processes.
- Longer approval time in comparison to residential loans.
- Considered riskier by lenders, leading to potentially unfavorable terms.
- High upfront costs and potential loss of liquidity.
- Possibility of a future balloon payment, requiring refinancing or additional loans.
How to Qualify for a Commercial Real Estate Loan
Qualification requirements vary among lenders, but there are some key factors to consider. Lenders may assess factors such as creditworthiness, business financials, and minimum experience in business ownership. SBA loans have specific caps for tangible net worth and average net income. It's important to assess whether you meet these criteria and gather the necessary documents before applying.
Down Payment on Commercial Real Estate Loans
Most commercial real estate loans require a minimum down payment of 20%, with SBA loans being an exception, starting at 10%. However, the required down payment may vary depending on the lender, the specific situation, and your business's financials. A higher down payment will result in lower monthly payments and reduced interest costs.
Repayment Schedules for Commercial Real Estate Loans
Commercial real estate loans offer a range of repayment plans to fit your business's needs. While a 30-year, fixed-rate mortgage loan is common for residential properties, commercial loans typically have repayment terms ranging from five to 20 years. Some commercial loan types even offer short-term financing with repayment due within a year. It's important to note that the amortization schedule may not align with the repayment term, potentially requiring a balloon payment at the end of the term. Early repayment may also come with penalties or fees, such as prepayment penalties or lockout clauses.
Interest Rates and Fees
Commercial real estate loans generally have higher interest rates compared to residential mortgage loans, averaging from 5% to 11%. However, rates can vary depending on the loan type, structure, and business financials. SBA 504 loans often offer lower rates, averaging below 3%, for small businesses that qualify. Closing costs for commercial loans typically range from 1% to 2% of the loan amount, which is lower compared to residential loans. Additional fees may be involved, including guaranty fees for SBA loans and prepayment penalties for early loan repayment.
Residential Loans vs. Commercial Real Estate Loans
Residential loans and commercial real estate loans serve different purposes and property types, resulting in distinct features. Commercial loans generally have higher interest rates, lower closing costs, prepayment penalties, and longer repayment terms compared to residential loans. Additionally, commercial real estate loans require a higher minimum down payment.
Applying for a Commercial Real Estate Loan
The application and approval process for each type of commercial loan may vary. It's essential to familiarize yourself with the requirements and gather the necessary documentation in advance. If needed, consider building your credit before applying and have a plan in place for loan repayment. Take the time to compare lenders based on their terms and thoroughly read the fine print to fully understand the loan agreement.
Finding the Right Commercial Real Estate Loan
The right commercial real estate loan for your business depends on your specific needs and financial situation. Evaluate each loan option carefully, considering factors such as repayment terms, interest rates, fees, and whether a personal guarantee is required. Thoroughly compare lenders and understand the total cost of the loan over its lifespan. Remember, there is no one-size-fits-all loan, so take your time to find the best fit for your business.
Conclusion: Unleash the Potential of Commercial Real Estate Loans
Commercial real estate loans offer small business owners the opportunity to expand their businesses and invest in valuable properties. However, it's crucial to carefully consider the terms and requirements of each loan type before making a decision. Take the time to understand the repayment structures, fees, and potential risks associated with commercial real estate loans. By doing so, you'll increase your chances of finding the loan that best suits your business's needs. Explore Nav's Business Loan Builder plan to set yourself up for success and secure the right loan for your commercial real estate ventures.
