A guide to Commercial Real Estate Loans.
There is a major difference between borrowing for a home loan and borrowing for commercial real estate. But what exactly is a commercial real estate loan?
What is a Commercial Real Estate Loan?
Any property that has been designed to make money is called a commercial real estate. And commercial real estate loans are for the purchase or renovation of these properties recognized as owner-occupied real estate. Which means at least 51% of the property must be inhabited by the business themselves. Properties include office buildings, retail centers, industrial warehouses, apartment complexes, etc.
Commercial real estate is not the same as residence and thus, the loans also differ from residential mortgages. Since small businesses have a higher risk factor, commercial loans require more detailed business plans and come under more scrutiny. Whereas, for a residential mortgage, no lender asks anything regarding how you are going to be decorating your living room.
Commercial real estate loans also have shorter repayment terms than residential or home loans do. Where a home mortgage is for 30 years normally, commercial real estate loans have a negotiable range of 5 to 20 years. Because there are shorter terms, the penalties put in place for early payment on these commercial real estate loans are also stiffer. This is to protect the lender’s final take. To get a business loan from a bank is more difficult than from an online lender such as Fora Financial.
However, commercial and residential real estate markets do have one major similarity and that is that no amount of money can help overcome a location that was ill-selected.
Types of Commercial Loans
There are several different types of commercial real estate financing. But the three most important ones to small-business owners are: traditional commercial mortgages, SBA 7(a) loans and CDC/SBA 504 loans.
All three require you to have on-premise occupancy by at least 51% of the business with repayment terms of around 5 to 20 years including business plans.
Traditional Commercial Mortgage Loans
Traditional commercial mortgage loans are not backed by the federal government but these loans have been made strictly between the borrower and the bank. These mortgages do not have a mandated cap but it is up to the lender to decide the maximum loan amount.
This maximum amount is determined to be between 65% to 85% of the loan-to-value (LTV) comparison. The down payment would cover 15% to 35% of the fair market value of the property whereas the interest rates on traditional commercial loans range from 4.7% to 6.75% and monthly payments are reduced over the duration of the loan’s term.
Traditional commercial mortgage loans require you to have a higher personal credit score (700 or higher), they also have fewer years in business, usually just one compared to government backed options that have three or more.
Banks and commercial lenders tend to require high qualification since the government is not sharing in the risk. So if you have a business that is well established and profitable and has a solid credit score, a traditional commercial mortgage would be your best bet.
SBA 7(a) Loan for Commercial Real Estate
In case you have been turned down for a traditional commercial mortgage, the most viable option for you then would be a government backed SBA (Small Business Administration). You might even be required to get rejected for a standard bank loan in order to apply for an SBA loan. The interest rates are typically lower for SBA loans along with the credit score requirements. However, the qualification guidelines for SBA loans are stricter.
The most common SBA loan is the 7(a) with the widest range of applications. The majority of these loans are given to established businesses that need to shore up their operating capital. However, they can also be used by newer enterprises to purchase commercial real estate.
An SBA 7(a) loan requires you to have a credit score of 680 or higher along with three years of business history with the repayment term is typically 10 to 25 years.
Please note that these loans are not made by the Small Business Administration itself but are made by SBA-approved lenders. They can be traditional banks, credit unions or private lenders. These potential borrowers follow the SBA’s guidelines because of which lenders have more faith that if there is a risky party, the loans will be repaid. This makes the lender more inclined to grant these loans, even to risky parties.
CDC/SBA 504 Loan for Commercial Real Estate
This kind of loan has been designed specifically for the purchase of commercial real estate properties. A CDC/SBA 504 is a combination of two loans: 50% of the money is from a bank or lender, 40% from a local community development corporation (CDC), and the remaining 10% is the borrower’s down payment. There is no maximum cap on the amount you can borrow on a CDC/SBA 504 loan.
Since the CDC/SBA 504 is a Small Business Administration loan, it is also backed by the government and requires the borrowers to have a 680 or higher credit score. However, the difference is that the borrowers are also required to meet the local CDC’s public policy and job creation goals.
The rates, fees and terms of the lender’s portion of the loan is not monitored by the SBA but the CDC’s is established. Interest rates for this type of loan falls between 3.5% and 5% along with a 1.5% CDC processing fee.
Since this SBA loan was specifically designed to aid community development and employment, if a company qualifies, it is expected to retain or create one job for every $65,000 that they borrow. If you have a business that is expected to grow quickly but you do not have cash on hand for down payment for a new real estate property, a CDC/SBA 504 loan might be a good option for you rather than a more broadly defined loan.
What are Typical Commercial Loan Terms?
Can you get commercial loan terms up to 30 years? Yes, it is possible. However, the commercial loan terms you are getting mostly depend on the purpose of the loan and the property that is used as security.
The standard commercial loan terms include 30 year terms with up to 5 years of interest. If it is a standard commercial property (freehold), the terms can be 10, 15, 20 and 25 years. If it is a purpose-built commercial property then the terms are typically 10 to 15 years, although some lenders offer up to 25 years as their standard policy.
The extra repayments are unlimited and there are no fees applied after the fixed period ends. Banks usually insist on principal and interest (P&I) for commercial loans that are under the $1 million blanket.
You can choose to get a longer commercial loan term by buying a standard commercial property or using a residential property as security. This can lead you to secure a loan term of up to 30 years. This is applicable even if your loan-to-value ratio (LVR) is high. In case you do not have a residential property, you can still get 25 year terms with an interest only period.
No matter what kind of commercial real estate you are looking for, you are bound to find a loan for it. Due to the rise of lenders and marketplaces online, you now have the option for more customizable options and ways to acquire capital.
Since owner-occupied commercial real estate essentially acts like its own collateral, the interest rates of commercial real estate loans are usually lower compared to other business loans. This ends up making them a smart option to try when looking to start your small-business career. But in order to do that, you have to make sure you are making the best decision since a real estate investment like such is not an easy decision nor should it be taken like one.
One of the best ways to ensure that you make the best decision when it comes to your real estate investment is to use a commercial loan calculator. Even though there are multiple small business loans that help you determine the general cost of the loan you are buying, a commercial loan calculator has been specifically designed to not only tell you the general costs of the loan but also take into account specific variable like amortization terms, P&I payments and a balloon payment.
Not only can you compare lenders with a commercial loan calculator but also compare various lending scenarios based on loan terms, amount and rates.
Once you have done that and found out what are the typical commercial loan terms and what you can get, you should speak with a mortgage broker to properly assess your financial situation and borrow at the maximum loan-to-value ratio (LVR) based on that assessment.