Thinking of buying commercial real estate like office spaces or an apartment complex? You’ll likely need a commercial real estate loan to help you make the purchase.
There are quite a few loan options out there for commercial properties and choosing the best one for your situation can take a little bit of research. Here’s a look at the commercial real estate loan types and what they mean for you as a borrower.
What is a commercial real estate loan?
As its name implies, commercial real estate loans are designed for individuals and businesses who are looking to purchase commercial or income-producing properties.
Despite being for real estate, commercial property loans differ from consumer mortgages. Here are a few of the key differences.
Consumer mortgages are typically used to purchase properties that you intend to inhabit. They can sometimes be used to finance rental properties, including single-family dwellings and multi-family dwellings with less than five units.
Commercial real estate loans are used to purchase commercial spaces like offices or warehouses. ”
Commercial real estate loans, on the other hand, are used to purchase commercial spaces like offices or warehouses. They can also be used to purchase larger multi-family dwellings, such as apartment complexes.
The Application Process and Requirements
The exact application process for a commercial loan will differ depending on the type of loan. In general, commercial loans are harder to qualify for and have a longer approval period.
Requirements are more stringent. After all, lenders have more money on the line, and it’s riskier. If your business or investment strategy fails to generate the income you expect, how will you make your payments?
Lenders will use a lower loan-to-value ratio to determine how much money they can extend to you. With consumer mortgages, some borrowers can qualify for nearly 100% financing. However, with a commercial loan, that number will be around 75% to 80%. They will also consider your DSCR, or debt service coverage ratio, which measures your ability to repay the loan with your existing cash flow.
Unlike conventional 15-year and 30-year mortgages, business loans typically have much shorter loan terms.
Like a consumer mortgage, the commercial property will be collateral for the loan that you take out. However, some loans and lenders may also require a personal guarantee depending on your situation.
Types of Commercial Real Estate Loans
Not all commercial loans used for real estate are created equal. Here are some of the most popular types.
1. SBA Loans
The United States Small Business Administration (SBA) offers two loan programs for commercial real estate financing. Similar to how the Federal Housing Administration guarantees FHA loans, the SBA provides guarantees for commercial loan programs. This means that you’ll still apply and go through an approval process with a commercial lender to get all or most of your funds; the SBA will back what they lend you.
SBA 7(a) Loans
The 7(a) loan is the SBA’s most common loan program. This loan is great for real estate purchases, though there is flexibility in how you can use the funds. In order to be eligible for this loan, your business must meet certain criteria, which can be found on the SBA website. Approval factors include your business income, your credit history, and where you operate.
SBA 504 Loans
504 loans offer fixed-rate financing for major fixed assets including existing buildings or land. Similar to the 7(a) loan, the SBA has a set of guidelines for the 504 loan program eligibility. Some of these requirements include qualifying as a small business, having management experience, and a feasible business plan.
However, unlike an SBA 7(a) loan, the 504 loan is not funded entirely through a private lender. These loans are made available through Certified Development Companies (CDCs), which are nonprofit corporations that promote economic development within their communities. Typically, a private lender will fund 50% of the project and a CDC will finance up to 40%. The CDC will coordinate and structure the exact financing plan.
2. Permanent Loans
No, a permanent loan doesn’t mean you’ll be paying it back forever! It’s simply a term that describes a first mortgage on a piece of commercial property.
These are your basic, fixed-rate or variable rate loans offered by most commercial lenders that most closely resemble a consumer mortgage. They typically have a longer amortization schedule than other business loans and can be crafted to fit your unique needs.
3. Hard Money Loans
Hard money loans bypass the traditional lender route. They are issued by private companies or individuals and typically don’t require much proof that you can repay the loan. Instead, they are much more concerned with the value of the property. If you default on your loan, they’ll make their money back by taking and selling it.
This makes the approval process easy, but the interest rate is typically much higher than that of a permanent loan. On top of that, you’ll have to repay the money in a short amount of time, usually between one to five years.
4. Bridge Loans
Bridge loans are offered by financial institutions but have some similarities to hard money loans. It’s a short-term option (usually one year or less) that also has a high interest rate. The goal of a bridge loan is to provide funds and sustain cash flow while you are improving, refinancing, or leasing up a commercial property. It can also be used while you are waiting to secure long-term financing.
5. Blanket Loan
If you plan on buying several properties, a blanket loan can help make the process a little more manageable. With this type of financing, you can have one lender, one payment, and one set of loan terms for multiple properties.
While this seems like a dream, there are several downsides. For one, it can be hard to sell off individual properties since they are all tied together. Secondly, since all the properties are collateral for the others, if one fails to bring in the money that you expect, all of your investments could be in jeopardy.
Finding the Right Commercial Property Loan for You
Understanding the difference between the types of loans is important for getting the financing you need for your business. If you’re unsure which commercial real estate loan is right for you and your situation, a lender will be able to help you weigh your options and point you in the right direction.
Looking for a Commercial Real Estate Loan?
Amplify’s commercial lending team can help you find the right loan for your business!