Key Takeaways
- A commercial loan is a type of loan used to finance commercial real estate investments.
- Qualifying for a commercial real estate loans starts off with evaluating your liquidity, net worth and investing experience.
- Get to know 6 common types of commercial real estate loans, including their typical terms and eligibility requirements.
If your investing career has pertained to residential real estate thus far, making the jump and applying for commercial real estate loans may seem like a big hurdle. Learning the basics of how to finance commercial real estate, however, is the very first step to achieving your goal of expanding and diversifying your investment portfolio. Read on to learn all about all the different types of commercial real estate loans, so that you can start making preparations for securing your next deal.
What Is A Commercial Loan?
A commercial loan is a type of loan that is used to finance investments in commercial real estate. For example, loans for commercial real estate might be used to acquire an office building, a mixed-use development project, or apartment buildings. Some investors may even use commercial real estate loans to develop or renovate commercial projects as well.
Commercial loans for real estate are unique from traditional mortgages for residential real estate in several ways. First, commercial loans are often found at smaller, community banks rather than big banks that are well-known. In addition, banks tend to hold these loans in their internal portfolios, rather than selling them on the open market. As a comparison, traditional loans are often bundled and sold to entities like Freddie Mac or Fannie Mae. One of the attractive qualities distinguishing commercial loans from traditional financing is the amount of flexibility offered to investors. There are generally less restrictions when it comes to ownership, property type and number of properties owned within the portfolio, and properties can be titled within an LLC.
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Commercial Real Estate Loan Rates
According to C-Loans.com, commercial real estate loan rates tend to be roughly 0.5 to 1 percent higher than a 30-year residential mortgage rate, or what we might call “traditional” financing. However, it should be made clear that rates vary greatly based on several factors, starting with the different types of commercial real estate loans that are available on market. For example, a commercial loan from a bank may have an interest rate between 5 to 7 percent, while hard money commercial real estate loans might range between 10 to 30 percent. Certain factors pertaining to the borrower will also affect commercial rates. Examples of factors include the borrower’s credit score, how long they have been in business, number of past projects, and available cash assets for a down payment.
Business owners will also encounter loans with either fixed or floating rates. A rate is fixed when the mortgage rate remains the same over the duration of the loan. Loans with floating rates, or variable rates, associated with a loan will change based on market rates. The lender will determine whether they can offer either a fixed or floating rate loan based on the loan type and the borrower’s qualifications.
Investors should also familiarize themselves with the concept of an “LTV” ratio versus an “ARV” ratio. A loan-to-value (LTV) ratio measures how large the loan is, relative to the value of the property. When taking out commercial real estate loans, the lender will often utilize a ratio when defining the terms of a loan, rather than a dollar amount, because commercial properties can vary so much in value. ARV, or after-repair-value, measures the size of the loan relative to the value of a property, after repairs have been made. An ARV ratio is commonly used when the loan is used for a rehab or renovation property.
Loans For Commercial Real Estate: How To Qualify
Loans for commercial real estate are appropriate for financing residential buildings with five or more units, or properties designed for businesses or institutions. Lenders treat commercial real estate loans much differently from traditional mortgages, so much so that some may think of it as a separate industry. The following provides recommendations on how to best qualify for loans, including commercial real estate construction loans.
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Improve your credit score: Credit scores are a critical factor when it comes to residential mortgages, but is not necessarily a top consideration for commercial loans. Nevertheless, it is still important to have a strong credit score. Aim to improve your credit score to at least 600.
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Increase your net worth: As a rule of thumb, lenders will want your net worth to equal at least the total loan amount. Your net worth is calculated by subtracting liabilities from your total assets.
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Have access to liquidity: Lenders will take a close look at how much liquidity you have. Not only will they want you to have enough cash for the down payment, they will show preference for borrowers who have enough liquidity to serve as a cushion in case there is an emergency or a need to pay for insurance claims.
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Expand your portfolio: Another factor lenders will evaluate is how long you have been in business, and how much experience you have. Some types of commercial real estate loans will even have a requirement for number of years in business, or number of previous projects. By expanding your investment portfolio, you can demonstrate to lenders that you have diversified experience in spearheading successful investment projects.
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Provide evidence of income: Similar to any other type of mortgage loan, a lender will require a proof of income, as well as cash flow statements if you already have a portfolio of real estate investments.
Types Of Commercial Real Estate Loans
- Small Business Administration (SBA) 7(a) Loan
- Certified Development Company (CDC) / SBA 504 Loan
- Conventional Loan
- Commercial Bridge Loan
- Hard Money Loan
- Conduit Loan
The list above illustrates some of the common types of commercial real estate loans available to investors. If for anything, it should help demonstrate that there are a myriad of different loan products to evaluate, each with unique terms and eligibility requirements to help fit your needs. Some commercial real estate loans are backed by federal entities, such as the Small Business Administration, while others are offered by private entities. Some loans are intended for owner-occupied investments, in which the borrower’s business is required to occupy a minimum of 51 percent of the building. Investors should also evaluate whether they are looking for a short-term or long-term loan, how much of a down payment they can make, and how quickly they will need the loan.
Check out the infographic below to find out 6 common commercial real estate loans, what scenario they are best for, their terms, and eligibility requirements:
When it comes to commercial real estate loans, the bottom line is in ensuring that you have the type of financial profile and experience that will get you approved for the type of loan you desire. Furthermore, there are several niches within the realm of commercial real estate to choose from. Do you want to become an investor in leisure, retail, office or industrial real estate? Do you want to specialize in mixed use development projects? Although the wide availability of options may seem overwhelming at first, answering these questions will only help you in devising a strategy on entering the commercial real estate market.
If you were to go into commercial real estate, what type of investing niche would you select? Or perhaps you would build a portfolio with different types of commercial properties? Feel free to share in the comments below:
