If you’re looking for the capital to purchase or renovate your investment real estate, then you will likely want to narrow your search to commercial loans or commercial real estate loans.
With commercial real estate loans/commercial financing, you can access financing for the specific purpose of buying, refinancing or adding value to your investment real estate. —additionally, the property that you purchase or add value to with the proceeds will, in turn, act as collateral for that same loan.
So, how do commercial real estate loans work? What are the best options for financing my commercial property?
In this commercial real estate overview, we will not only answer those two questions but we’ll explain what a commercial real estate loan is -the types of terms and rates for a commercial loan and how to apply. Whether you are a first time investor or a seasoned expert you should find this commercial real estate financing guide useful.
What Is A Commercial Real Estate Loan
What Are The Different Loan Types
How Do I Apply For my Commercial Loan.
What Is a Commercial Real Estate Loan?
First, let’s start with the basics: What is a commercial real estate loan?
As we mentioned briefly above, a commercial real estate loan is a financing product (often referred to as a commercial mortgage loan designed specifically for the purposes of purchasing a new or existing commercial properties or renovating commercial space. In this case, commercial real estate refers to any kind of property that you use for business purposes—a brick and mortar store, self storage, shopping mall, office building, or manufacturing facility. Land or mixed-use properties like multifamily apartment buildings are also considered commercial real estate.
With commercial real estate financing, the commercial property that you’re buying or renovating actually serves as the collateral for the loan.
This being said, like other types of asset-based loans, commercial real estate financing definitely isn’t one size fits all. There are several types of commercial real estate loans, they vary in terms, rates, loan amounts, eligibility requirements, length of the application process, and fees required.
5 Best Commercial Real Estate Loans
Traditional and Mortgage Bank Loans
Traditional and mortgage banks typically have the best leverage at the lowest cost. Conventional banks are difficult to qualify for. Generally, you need a high credit score and strong business financials in order to qualify for a commercial mortgage for your bank. Mortgage banks typically have better terms, easier underwriting guidelines and can even provide longer terms than most traditional banks.
SBA Loan (Small Business Association)
SBA loans will offer some of the best rates and terms for commercial real estate loans after banks but the process to qualify can be grueling and the length of time to close may not work for many investors. The SBA has two loan programs that can be used for real estate loans the 7(a) and the 504 CDC loan program. The 7a is the general purpose loan that can be use for acquisitions as well as construction for improvements. This loan can go up to $5 million dollars with an amortization of up to 25 years.
SBA 504 loan helps small business purchase and upgrade commercial real estate properties. A bank and SBA approved non profit lender work together to provide loans with interest rates starting in the low 3s.
A commercial bridge loan is a short term commercial loan that allows you to quickly buy property when an opportunity presents itself. Bridge lending today is one of the best ways to capitalize on opportunities and quickly acquire commercial real estate. These loans are used to acquire and rehab or expand on your real estate investment. Once your project is completed a bridge loan is typically refinanced with longer term financing.
Hard Money Loans
A Hard Money Loan is a short term commercial loan from a private lender that allows you like a bridge loan to quickly buy property when an opportunity presents itself. A hard money loan has much easier underwriting requirements and only has to pass the private investors due diligence in order to close. Today the line between hard money and bridge loans is blurred. Fix and fix loans and bridge loans today pretty much have the same terms and rates. Cambridge Capital provides bridge/hard money and can provide the stabilized takeout once your investment is stabilized.
Loan-to-value (LTV) is the size of your commercial real estate loan relative to the purchase price of the property you’re buying. For commercial real estate finance, banks usually go up to a 90% LTV ratio, whereas short-term commercial real estate lenders usually lend only 50% or 60% LTV. Whatever your loan doesn’t cover, you’ll have to bring as a down payment.
Let’s say, for example, that you’re purchasing a $200,000 piece of property. Banks might lend up to $180,000 for qualified borrowers, and you will have to put up a $20,000 down payment. For the same piece of property, a short-term lender might only lend $120,000. You’ll then have to put down an $80,000 down payment.
LTV also correlates with the cost of a commercial real estate loan. The greater your loan down payment, the lower your interest rate is likely to be.
After-Repair Value (ARV)
On the other hand, some commercial real estate lenders lend money based on the estimated after repair value (ARV) for renovation projects. ARV is the estimated value of a piece of property after any intended repairs are finished. Short-term lenders often lend up to 70% ARV.
Your Credit Score
As with other types of small business loans, the commercial real estate loans you can qualify for will depend heavily on your credit score.
Of course, commercial financing companies prefer to work with borrowers who have a track record of paying back their debts on time and managing their finances well. To evaluate this, lenders will look both at your personal credit score and at your business credit score.
This being said, there’s no fixed credit score that you must have to qualify for commercial real estate loans, but there’s a progressive range across lenders. The easiest-to-access commercial real estate loan lenders are hard money lenders, and they’ll usually require a minimum credit score of around 550.
On the other end of the spectrum, if your credit score is 700 or higher, you’ll be more likely able to access the most desirable commercial real estate loans available to you—like an SBA loan and a traditional mortgage from a bank.
Real Estate Collateral Value
As we’ve mentioned, commercial real estate lenders aren’t just looking at your personal and business finances when determining if you qualify—they’re also looking at the property you’re purchasing or renovating.
A loan for commercial real estate is an asset-based loan, meaning that the property itself acts as collateral for the loan. If you can’t pay back the commercial real estate loan, the lender has a lien on the real estate and legal rights to seize and sell off the property to satisfy the debt.
Since the value of the property affects the lender’s security interest in the loan, lenders will care about the property you’re purchasing and renovating. They’ll want to see a full valuation and appraisal of the property to see whether it will be sufficient to protect the lender’s assets.
If you’re planning to do a full-scale renovation, the lenders will also be interested in the after-repair value (ARV) of the property. As we discussed above, some lenders base the maximum loan amount they’ll approve you for based on the ARV.
Debt Service Coverage Ratio
Lenders will look at your debt service coverage ratio, or DSCR, to make sure you have the financial capacity to pay off the loan comfortably.
A DSCR is a measure of a company’s cash available to pay its current debt obligations. This number gives a picture of whether the business will be able to service its debt on an average month or year.
Your DSCR is calculated by dividing your annual net income (your sales minus your expenditures) by your annual loan payments. For example, let’s say your net income is typically $300,000 in a given year, and you expect your annual loan payments will be $50,000. This means that your DSCR is 6—which is extremely healthy.
A DSCR that’s greater than 1 means your business has more than enough cash coming in to make loan payments. A DSCR of 1 says that you have exactly enough cash on hand to make your loan payments—but you don’t have a cushion for unexpected costs. A DSCR of less than 1 says that your business is operating with negative cash flow, and you don’t have enough cash on hand to meet your debt obligations.
All of this being said, lenders usually look for a DSCR that’s greater than 1.2 when evaluating your commercial real estate loan qualifications.
How to Apply for Commercial Real Estate Loans
If you think you can qualify for a commercial real estate loan, the next step will be the application.
Due to all the different parts associated with this type of loan, applying for commercial property financing can require significant documentation. In particular, if you’re applying with a bank (for traditional or SBA loans), you can expect an intensive and slow-to-fund process.
With alternative lenders, on the other hand, you can expect fewer business loan requirements, although there are still some basic documents you’ll need.
Here’s some essential paperwork to gather for your commercial real estate loan.
Business Owner Information
First, you’ll need basic information about the business owners, including:
- Name and ownership percentages for key owners (anyone who owns 20% or more of the business)
- Resumes/background information for key owners
- Corporate documents (e.g. articles of incorporation, certificate of good standing, bylaws, etc.)
- Company organization chart
General Property Information
Next, you’ll need information specific to the property you’re buying or renovating, such as:
- Purchase contract
- Project address and description
- Market analysis for the property/business plan
- Budget for the project (especially if it’s a renovation)
- Environmental reports
- Existing conditions report from the architect or engineer
- Scope of work for any renovations
- Blueprint of the property
- Design plan or scope of the projected commercial real estate work with milestones
- Name and contact information for architects and contractors
Personal and Business Financials
Finally, you’ll need both personal and business financial information, such as the following:
- Personal credit report for all key owners (the lender will obtain this; you just need to provide your SSN)
- Documentation of any personal sources of income for all key owners
- Last two to three years of personal tax returns of all key owners
- Project budget
- Sources of revenue while construction or renovation is underway
- Projected business revenues and profits for the next three to five years
- Any other debt you have for this project or for other parts of the business
- Last two to three years of business checking account statements
- Last two to three business tax returns
- Last two to three years of financial statements (profit & loss, balance sheet, statement of cash flows)
- Current accounts payable and accounts receivable aging report
- Rent roll (if the property is a rental property)
- Lease (if the property is a rental property)
The Bottom Line
At the end of the day, there’s no doubt that commercial real estate loans will be a little more complex than your traditional financing options.
This being said, however, you’ll likely want to start your search with a representative from Cambridge Capital as these products will offer the most desirable terms and rates. If you can’t qualify for these types of financing, then you’ll want to explore some of the other options we’ve discussed—such as bridge loans, short-term online loans, or hard money loans.
Ultimately, as long as you plan ahead, consider your needs and what you can afford, and shop around for the best offers from multiple commercial lenders, you should be able to find the real estate loan that’s right for your business.