Do you lease your commercial property and prefer to own it instead?
In need of funding to buy some sort of commercial property office space or an office building, retail space, industrial, warehouse or even apartment/multi family. If so keep reading this guide!
Business owners need a place to do their thing and run their business. Many conduct business at a store front, in an office or at a warehouse. Others like property investors are looking for sources of capital to purchase multi family apartment buildings.
Commercial property in many cases can be expensive. When the need arises to purchase commercial real estate for your business or investment needs, getting the right type of commercial mortgage is important. Lets look at how to finance commercial property, commercial mortgage loans and commercial mortgage rates that are affordable as well as being a good fit for your business.
So let’s take a look at what you should know about looking for and obtaining a commercial loan.
Discovering more about what is a commercial mortgage loan?
What are the commercial real estate loan rates, fees and repayment schedule?
What is required to qualify for a commercial mortgage?
Why Apply for Commercial Financing
If you are still on the fence about obtaining this type of funding source for commercial real estate, why does a business owner look into getting one?
If a business leases their space, depending on the terms of the lease and property owner, a business owner occupying that leased space may not be able to develop or renovate it, unless they own the commercial property.
On the positive side – when your business is successful and growing, there may be a need to buy more property or invest some money into the current space. On the down side, someone may need to apply for a commercial mortgage loan because renovate a current property because it may have had damage occur.
Not all businesses have lots of cash on hand to go out and purchase a property outright, so that is where a commercial mortgage financing for commercial real estate comes in.
What is a Commercial Mortgage Loan?
If you are new at this and just starting your search, let us explain what this type of loan really is.
What’s the difference between this and a regular home loan?
Home loans are for residential property that contains 1 to 4 units, where inhabitants live.
A commercial mortgage loan is to finance the purchase of commercial real estate for a business owner or investor. As you go through this process you will notice many similarities with these 2 types of loans. Let us show some of the differences.
Let’s look at the differences between a “loan” and a “mortgage”.
In many regards, mortgages are usually referred to as a loan and you will also see us do the same through out this article.
But did you know that a mortgage really is not a loan?
When someone needs money, they apply for a loan and if approved, a lender gives it to them.
In the case of getting a mortgage, it is actually a security instrument and is given to the commercial mortgage lender to secure the property.
Mortgage: noun; a legal agreement by which a bank or other creditor lends money at interest in exchange for taking title of the debtor’s property, with the condition that the conveyance of title becomes void upon the payment of the debt.
Since the commercial mortgage lender is investing into a property, they want to protect their interest while it is being financed in case of foreclosure.
There are two parties involved in this financial transaction;
The borrower – who is the mortgagor
The lender – who is the mortgagee
A lien on the property is created with this type of document for the subject property. The lien is functioning as a security for the bank/lender—if you are unable to pay the lender back, they have rights to seize the property and recoup their losses (which is called a foreclosure).
When financing the purchase or a property whether is residential or commercial, this document secures the lenders interest while it is being financed.
The Difference Between Residential & Commercial
In regards to residential property and commercial property, there is a unique distinction that can be easily clarified below…
And that is in order to be qualified for commercial mortgages, one needs to by buying commercial real estate.
Property that is earning an income is actually what commercial real estate is.
If you are operating a local retail business, then your store is your commercial real estate. For those that operate a business online and are occupying office space with employees, then where that business is being operated is the commercial real estate. Just like hotels and warehouses. Multi family apartment properties that contain 5 units or more are also commercial real estate.
All of these can be purchased, developed, and renovated.
For the purchase, construction, or renovation of commercial real estate, it may not be affordable to some people / investors. So that is where business real estate loans will play a part.
How Do Commercial Real Estate Loans Work?
It’s no secret that commercial real estate can be expensive to purchase and invest in. But it’s this type of commercial property financing that is going to make the deal you find possible. OPM (other people’s money)
Be aware that a commercial mortgage requires a lien.
A lien is a legal right that an owner of a property gives to a lender, serving as a guarantee for the repayment of a business mortgage loan. If the owner can’t pay the loan back fully, that credit might be able to seize the asset secured by a lien. This gives the creditor some protection against the inevitable risk of default.
The lender will place a lien on your property and it is filed with the county where it is located.
When financing commercial properties a down payment is usually required. Typically 10 to 20% down, which you will see this being referred to as a LTV90 (10% down) or a LTV80 (20% down) by your loan officer.
We already know that real estate loans on residential property are amortizing, where you repay the financing in regular installments over a fixed period of time, however for commercial mortgages there are 2 types of mortgage loan repayment schedules.
- The first one are Immediate-term loans (of 2 years or less).
- The other is a long term loan which is between 5 to 20 years.
A CRE balloon loan or a fully amortized loan is how the repayment may be structured. When a loan is amortizing, it is paid back in fixed installments including interest, until all of it is paid back.
A balloon loan is a loan where the balance due, to pay off the remaining principal, is paid in one big payment. Investors who use this loan type want smaller payments and may have an exit strategy (selling the property) before balloon is due. Kind of risky.
Be sure you completely understand the payment structures that are available for your loan. By the way, please consult with someone who is qualified to give advice in this regard. The loan repayment will affect your cash flow. As far as the balloon note goes, it could pout a big burden on cash reserves, if a borrower is not prepared to pay such a large amount of money.
Commercial Mortgage Interest Rates
Residential mortgage loan interest rates and commercial mortgage loan interest rates are two different things. Don’t expect them to be the same. Business real estate loans do tend to be higher than home loans.
Why is that? It is because these are riskier loans, especially if the borrower is a startup company or been in business less than two years. Additionally, businesses tend to have credit histories that are less established than individuals.
Another factor that affects a commercial mortgage loan rate is that they will vary depending on who offers it and what are their rates / terms. Banks and credit unions usually have rates around 3.5 to 6%. Life insurance companies also lend money in this space and have lower rates around 3.5% to 4.5%. (at the time of this writing) Feel free to contact us to get current rates.
Those Dreaded Loan Fees
So in regards to other business mortgage loans do have fees that need to be paid upfront. To cover the costs of the loan fees are usually bundled into them. These fees cover items such as: property appraisal, survey fees, application fees (if required) , origination of the loan and legal costs. Depending on which lender the loan is being underwritten by, these fees may be required to be paid at closing. Other lenders may want those to be paid annually. Your commercial mortgage loan officer will advise you about the terms.
Other terms that you will want to know about are prepayment penalties, if any, if a loan is to be paid off early. Lenders earn their money by the interest you pay. If you payoff early, they will not make as much money as they were expecting based on the amortization schedule. This varies by each lending institution.
All commercial real estate mortgage loans have a loan agreement. This is where you can see all of the fees, commercial real estate loan rates and other information. Fully read and understand it before putting your signature on it.
The Application Process for Commercial Loans
Here is what to expect when you begin the commercial loan mortgage application process. Using a commercial mortgage broker is a great idea when filling out the application. The following will begin you give you an idea and set expectations.
Do you have a home loan already? If so, then you are already with the process of a residential home loan. Applying for commercial mortgages is actually a different process. This is because commercial mortgages are not backed by a government agency like FHA or Freddie Mac.
Loans for homes are frequently backed by the Federal National Mortgage Association (commonly known as Fannie Mae). As such, this makes qualifying for residential home loans easier.
So as we discussed already, residential home financing has lower interest rates because the government is backing the loan and reducing risk to the lender. The commercial mortgage lenders are taking all the risk with no government backing, thus resulting in slightly higher interest rates.
Commercial mortgage lenders need to dig deeper into the borrower’s ability to repay the loan. So besides looking at the property to be purchased, the underwriter will also want to see more information about the business because there is more risk in lending money to a business. It is the businesses responsibility to payoff the loan as agreed. However survival rates of small businesses in the Untied States can be poor. The lender wants to know if the business will be around long enough to pay off this obligation. Ask your commercial broker for assistance, if needed.
What Are the Mortgage Underwriters Looking For?
So as you prepare to apply for your commercial real estate loan, it’s beneficial if you know what will be expected during the application process.
To improve your chances of loan approval success then you need to know what there are looking for while it is being processed.
Every lender has its own under its own underwriting guidelines as this process is not uniform across all lenders. Each one has its own appetite for risk. What I will show you is what you should be prepared for.
What’s a LTV Ratio?
This is very important because your LTV ratio (loan-to-value) is used a one of the biggest loan approval factors.
Loan-to-value ratios. The loan-to-value (LTV) ratio is a financial term used by lenders to express the ratio of a loan to the value of the commercial property purchased.
Commercial real estate lenders want to see you put some of your own money into the deal. Down payment amounts vary between all of the lenders, but be prepared to have a down payment before beginning this process. If you put 20% of your own money down, then the LTV is 80, as 80% of the funds are from the lender.
The more money you are able to put down on a property, then the lower your loan to value ration will be. A lenders risk is reduced by the borrower being able to provide a bigger down payment. The lender is now be able to lend less money.
The amount you are able to put down will result in what you will be qualified to receive and the best rate they can offer.
Collateral & Property Information
The subject property will be evaluated by the lenders underwriting team. This will also determine what you qualify for.
The collateral that will be used for your loan is the subject property being financed. This is another part of the process of securing the loan. All mortgages have an acceleration clause, so if you are unable to make those payments, they can demand the full balance and foreclose.
A full appraisal of the property will be needed as the property is being used to secure the loan.
In some situations, a borrower can provide additional collateral for the commercial mortgage loan besides the property itself. Some lenders may accept collateral like receivables, contracts, or the guarantor’s personal guarantee in addition too the commercial property
Doing this could put more of your assets at risk although it can increase chances of getting an approval.
Borrowers Credit Score
For a home loan, a credit score is the most important thing that a lender will look at. But in the world of commercial real estate loans, it is not as important, but it does still get reviewed for an overall ability of the borrower’s monthly payment habits.
If you happen to have a good credit score, then it is going to make you and your application look much better. Likewise if you have a low credit score, then most likely this could negatively affect your application as in getting disqualified.
Since there are so many different types of commercial mortgage loans out there, on average a 660 middle credit score would be required. All three credit bureaus will be checked and the score in the middle is commonly used. They will also dig in to see if you have any open tax liens, bankruptcies, foreclosures and judgments.
Your Liquid Assets
The liquidity in your business is taken into consideration. The lenders will be interested in seeing your liquid cash, and your cash flow.
When the underwriter gets your application, they will look at your liquid cash as to see what an acceptable and realistic LTV is and what you can take on.
So what they are actually looking for in this case is that if your loan required a big down payment would it exhaust your company’s cash flow? The other reason cash flow is looked at is to make sure you have the ability to make your regular monthly payments.
What are the cash liquidity requirements? Each lender has its own guidelines and requirements. Generally what they are looking for is to see cash liquidity of around ten percent to twenty percent of the loan amount. In simple terms if a borrower has a one million dollar commercial loan, then they should have at least $100,000 in cash liquidity when the loan is closed.
Your Experience as a Business Owner
The experiences you have as a small business owner will also be looked at by the lenders. The bad news is for entrepreneurs who have no experience in something and are new will have a difficult time getting any kind of financing. Since commercial mortgages are very big, inexperienced entrepreneurs will find it difficult.
Mortgage underwriters want to know that you are experienced in managing and growing a business, preferably one that is similar to they type you operate now. When they look into the past of a any borrower and see something like a bankruptcy, honestly they will not have to much confidence in your ability to run your business and manage your financials.
However if you have a history of running successful small companies that are profitable and cash flowing, that is a reassurance to them that you can manage your business properly.
What Types of Commercial Mortgages are Available?
We have gone over the basics of how a commercial mortgage loan works and items that the lenders are looking at when trying to qualify.
So you may be wondering what types of commercial mortgage loans are available?
Below we will go over the 4 most commonly used products on the market and each one has its own variation and uniqueness to accommodate the borrower’s needs.
Which one will work for you?
The Traditional Commercial Mortgage…
Remember we said that these loans come with no government guarantee. So a down payment is required.
Since you will not be able to get 100% of the properties’ value as a loan amount, if qualified you could get 65% to 85% property value. This means that the down payment range could be 15% down but as high as 30% down. There are some lenders out there that have lower down payment requirements too. The term length for these loans is generally 5 to 20 years. Most traditional commercial mortgages are fully amortizing. Contact us to get current commercial mortgage loan rates.
If you are in need of a long term mortgage loan and with higher loan amount limits, this may work for you. Rates are still low.
Qualifying for this type of loan, while it varies between lenders and to improve your chances in pre-qualification, they may be looking for
- Credit scores of 660 or higher. 700 is much better
- 1 or more years in business
- (DSCR) Debt Service Coverage Ratio: 1.25 or more
7(a) SBA Loans
A SBA 7(a) loan is the Small Business Administrations most widely used and popular type of financing that is offered by the SBA.
You can use a 7(a) loan for a wide variety of business purposes, including the acquisition and renovation of commercial real estate
This loan program offered by the SBA is also backed by the SBA. The loan amounts that are available are typically around 85% to 90% of a properties value. The Max loan amount is $5,000,000. They want to see the borrower put down 10% to 15% of the subject property purchase price. Length of loan can go as high as 25 years.
What is required for approval?
• Credit score of 680 or higher
• They want to see two years of stable cash flow
• At least two years in business
The CDC/504 SBA Loans
The SBA has another loan program that is for the purchases of commercial real estate and this program is the CDC/504 loans.
The CDC is a Certified Development Company and the CDC/504 loans are backed by them. The CDC/504 are two loans. One is where the SBA provides 50% of the subject property’s purchase price and the CDC will finance the other 40%. As a result a down payment of 10% will come from the borrower.
This loan is more complicated to put together than the SBA 7(a) loan and is also less commonly used.
The minimum qualifications are:
• Credit scores of 680 or higher
• DSCR of 1.25 or higher
• Owner occupancy of the property needs to be 51% or more
• A PG (personal guarantee) Got to be able to provide more than 20% in a personal guarantee.
Commercial Hard Money Loans
What is a hard money loan? They are actually a short term loan used to buy or renovate a commercial property. They will need to be refinanced into a long term, more traditional commercial mortgage. Interest rates are much higher on these types of loans and the term length is short.
In a way they are kind of like commercial bridge loans. It is easier to qualify. The processing time is relatively quick, short term and smaller loan amounts. If you have a deal that needs to close quick and need funding soon to make it happen, then a hard money loan could be the solution. You will need to look at obtaining a more long term loan though.
The down payment amounts typically for this type are around 10% to 20%.
Interest rates can range from 8 -13%. There are other costs involved as well like closing costs, lender fees and an appraisal may be needed.
• Credit score of 660 or better
• They would like to see one to three commercial projects from the past
Getting Ready to Start
The purchase of commercial real estate is a big investment and may take one to three months to process the loan. There will be situations where some of the loan products may be streamlined and closing could occur in less than 30 days! Ask your loan officer about this. For the time being, be prepared to put time and money into this. Using the services of experienced commercial mortgage brokers should be considered. Contact us if you need help.
Make sure you understand what you are buying and everything that will go into the processing of commercial mortgages. Take a look at your ability to repay the loan and know what your options are. Let us help you connect with a lender that offers the best commercial mortgage loan rates and terms.