Commercial Real Estate Loans: What You Need to Know
Whether you’re choosing office space for your new business or adding a second store across town, you may need to buy or build new property. And if you don’t have the money on hand to pay for it upfront, a commercial real estate loan could help.
- What is a commercial real estate loan?
- Types of commercial real estate loans
- Where to find commercial real estate loans
- How to get a commercial real estate loan
What is a commercial real estate loan?
Just as families use mortgage loans to purchase a home, businesses can use commercial real estate loans to obtain a new office or storefront. You could use a commercial property loan to build a stand-alone building, buy office space in a large mixed-use business center or even purchase residential property meant to be leased out to tenants. As long as the property you’re interested in building or buying will be used primarily for producing income, it’s likely considered commercial real estate.
|How it works||Who it’s good for|
|Traditional commercial loans||Similar to a residential mortgage, banks and other major lenders offer secured loans at competitive rates to creditworthy borrowers.||Businesses with good credit that need a long repayment term. This is the most straightforward option, and will probably be best for most borrowers.|
|SBA loans||The U.S. Small Business Administration at least partially guarantees loans disbursed by partner-lenders to help small businesses secure lower rates.||Small, for-profit businesses that are willing to delay funding in exchange for lower rates. SBA loan rates are competitive, but the complex underwriting required means you won’t get your funds as quickly as other types of financing.|
|Bridge loans||Lenders offer a lump sum of cash more quickly than other types of loans, but funds will need to be repaid in a shorter time frame. These loans are typically used to cover a gap in funding while a longer-term form of financing is secured.||Short-term real estate investors and those trying to out-bid cash buyers. If you won’t be able to repay the loan quickly, you should be prepared to refinance.|
|Hard money loans||Similar to a bridge loan, these loans are usually offered by private lenders, as opposed to banks and credit unions. Because of this, hard money loans may come with shorter repayment terms and higher rates.||Those who need to cover a short-term gap in funding, but haven’t had success qualifying for a bridge loan from a traditional bank.|
Types of commercial real estate loans
We’ll take a closer look at the loans described in the chart above.
Traditional commercial real estate loans
Traditional commercial loans are the easiest to understand because they work a lot like home mortgage loans. If you meet a lender’s eligibility requirements, you’ll receive a loan for the purchase price of your property, less the down payment and any fees you owe. Your property will act as collateral on the loan, and you’ll make payments according to the repayment term.
The terms and rates applied to each loan will vary from one lender to the next, but borrowers may be able to obtain fixed or variable interest rates starting as low as 3%, as well as balloon payments — a series of smaller payments leading to one, large payoff amount — if you need to reduce monthly payments at the outset of the loan term.
To encourage the success of small businesses and help entrepreneurs who can’t access credit elsewhere, the U.S. Small Business Administration will at least partially guarantee loans taken out by qualifying small businesses. This guarantee helps SBA-approved lenders offer better rates to businesses that would otherwise be stuck paying higher interest rates due to less-than-perfect credit or failure to meet other criteria, such as collateral or income requirements.
There are other perks to SBA loans: “Less money is required as a down payment, as low as 10% to 15% instead of 20%,” said Patrice McElfresh, a Small Business Development Center advisor in San Antonio.
If you want to use an SBA loan to buy commercial real estate, there are two loan programs to look into:
- SBA 7(a) loans: The SBA’s most popular loan program, the SBA 7(a) allows you to borrow up to $5 million. Lenders may require collateral. Repayment terms go up to 25 years on real estate transactions, and interest rates ranged from 5.5% to 11.25%, as of April 2020.
- CDC/504 loans: SBA 504 loans are actually a combination of two loans — an SBA 504 loan which funds up to 50% of the total loan amount, and a loan from a community development corporation (CDC), which typically funds around 40%. The remaining 10% constitutes your down payment. Real estate terms are typically 20 to 25 years with effective interest rates ranging from 2.85% to 4.00%, as of March 2020.
Be prepared. It may take longer to close on an SBA loan than other types of loans, although you can help the process along by promptly filing the required paperwork. There are also specific qualification requirements, depending on the type of loan you choose. For example, if you’re applying for a 7(a) loan, you’ll have to show your ability to repay, as well as your potential for long-term success.
According to McElfresh, however, “the advantages outweigh the negatives,” referring to the potential for lower interest rates and lower down payment requirements.
Commercial bridge loans
Just as the name implies, business bridge loans are meant to bridge a gap in funding. If you need a lump sum of cash quickly to, say, compete with other cash buyers on a real estate opportunity while you wait for permanent funding to come through, a bridge loan may be the answer. The main downside to these loans, however, is that while you can get funding quickly, it would need to be repaid quickly, too.
Here’s a closer look at typical rates and terms:
- Average rates: 5.72%-11.72%
- Average loan-to-value ratio: 80%
- Typical loan size: $1 million
- Typical maximum term: 36 months
Generally, you need good credit to qualify for competitive rates, which already tend to be higher than those for the types of loans above.
Commercial hard money loans
Hard money business loans operate in largely the same way as bridge loans — you get access to cash quickly, but you’d have to pay it back it quickly, too. The key difference between hard money loans and bridge loans is in who you borrow from and the qualification criteria.
Generally, bridge loans come from banks and credit unions, while hard money loans are offered by private lenders or investors. While good credit is preferred to qualify for any loan, hard money lenders may allow those with less-than-perfect credit to qualify, since they may be able to use their equity in the business as additional collateral. However, that leniency may come with higher interest rates, so you should look into bridge loans from major banks before settling for this form of financing.
Here’s a closer look at typical rates and terms:
- Average rates: 10%-18%
- Average loan-to-value ratio: 60%-80%
- Typical loan size: $150,000
- Typical maximum term: 12 months
“I would look for ‘hidden fees’ and ask for the annual percentage rate,” McElfresh said. “The rate may sound decent at 6%, but 6% per month would be 72% annually.”
Where to find commercial real estate loans
You can find commercial real estate loans offered by a variety of lenders, depending on which type of loan you’re seeking. Here are some of the top places to look by category: national bank, commercial lender and online marketplace. (Later, we’ll discuss other places to find commercial real estate loans.)
National bank: PNC Bank
PNC is the seventh-largest bank in the U.S., by assets. Like other large banks and credit unions, it offers a variety of consumer and corporate banking products, including loans for commercial real estate:
|Owner-occupied commercial loans|
|Use||Purchase or refinance owner-occupied commercial property.|
|Rates||Fixed or variable; contact to get an exact quote|
|Terms||Up to 120 months, with up to a 20-year amortization.|
|Eligible for SBA loan?||Yes|
|Line of credit available?||No|
Online commercial lender: Commercial Loan Direct
Big banks aren’t the only place to find loans. Commercial lenders often offer rates and terms that are competitive with traditional banks, and applying for a loan can usually be done from the comfort of your couch. Commercial Loan Direct partners with agencies, lenders and investment funds to provide funding to small businesses.
Borrowers have two types of loan options to choose from:
|Owner-occupied mortgages||Investment mortgages|
|Use||Renovating properties in which your business occupies more than 50% of the leasable space.||Buying or renovating properties in which your business occupies 0%–50% of leasable space.|
|Eligible loan types||Traditional commercial loans, SBA loans, USDA loans||Conduit/CMBS financing, loans from life insurance portfolios, bridge loans, construction loans*|
|Average starting rates||1.95%–6.25%||1.94%–10.99%|
|Terms||36–300 months||12 months-360 months (36 months for bridge and construction loans)|
|Minimum loan amounts||$1,000,000||$1,000,000–$5,000,000|
*There may be exceptions to loan types, amounts and rates, depending on your situation.
Online marketplace: SmartBiz
Online marketplaces have become increasingly common in recent years, due to the sheer number of loan options popping up online and the ease with which a marketplace can help you compare your options. SmartBiz specializes in SBA 7(a) loans, and its online platform may streamline the process of applying for an SBA loan — which, as we mentioned earlier, has a more complex underwriting process than other types of loans.
Here’s a closer look at the 7(a) through SmartBiz:
|SBA 7(a) loan via SmartBiz|
|Terms||Up to 300 months|
|SBA fee||Up to 3.75%|
|SmartBiz fee||No more than 1%. Additional closing costs may apply.|
Other types of lenders
The types of lenders discussed above should cover the needs of most small businesses. However, there are some additional funding methods and lender types that are worth looking into:
These lenders are more like brokers than actual lenders. A conduit lender will sell loans for other lenders and earn a commission after the sale. These loans may also be bundled with other mortgage loans and sold to investors. Conduit loans can come with competitive interest rates, but as always, you should compare multiple options to ensure you’re getting a good deal.
Peer-to-peer (P2P) lenders
P2P lenders, such as LendingClub, allow individuals to fund loans rather than banks and commercial loan lenders. Borrowers with less-than-perfect credit may find individual investors who are more willing to take on their loan through a P2P lender.
How to get a commercial real estate loan
Step 1: Get your business and personal finances in order
As with any loan, your current financial situation and credit history will play a major role in the loans you qualify for and the rates you receive. Although the exact criteria each lender will look at varies, here are some things lenders may want to see.
What lenders may look for in your personal finances
- Your credit score: To get good rates, lenders will generally want to see a personal credit score of about 680 or higher. You can certainly qualify with lower credit, but you’ll probably pay more for it. To improve your score, try to pay off any outstanding credit card debt and reduce installment loan balances.
- Your DTI and net worth: Your debt-to-income ratio and overall net worth will convey how responsible you are with money and how stable your current financial situation is.
- Liquefiable assets: Lenders may ask to see proof of assets, such as bank account statements, to gauge your ability to repay a debt should you face hard economic times.
- Your financial history: Although this is largely reflected in your credit score, lenders may delve into your credit history to see if you’ve had any recent cases of foreclosure, bankruptcy or loan default. They’ll also want to look at your personal tax returns.
What lenders may look for in your business finances
- Your business credit score: Your business credit score will fall somewhere between 0 and 100. Most lenders like to see a score of 75 or higher to offer the best rates, but this can also be balanced with a strong personal credit score. Reducing your business’s outstanding debts and increasing revenue are great ways to improve your credit.
- Your business’ assets: Does your business possess a significant cash reserve, pending invoices or valuable equipment that could be liquidated to pay off a real estate loan?
- Your NOI: Your business’ net operating income indicates how profitable your business is after all expenses are paid. Some lenders will impose a minimum revenue amount to approve you for a loan, while others — chiefly SBA lenders — may also impose a maximum revenue amount.
- Time in business: Depending on the lender and type of loan you’re applying for, you may need to prove you’ve been in business for a minimum number of years. Tax returns from prior years can be used to prove both your business’ history and average NOI.
- Licenses to do business: Do you hold the proper licenses and certifications to conduct your business?
Step 2: Document the property you’re interested in
To apply for a loan, you’ll need to provide the lender with information about the property you’re interested in buying. These details will vary based on the lender and property you’re buying and will help a lender evaluate how to underwrite your loan.
- What’s the address?
- What type of property is it (residential home, apartment building, mixed-use building, standalone retail space, etc.)?
- If relevant, what is the owner-occupancy rate of the property? (What percentage of the property’s leasable space will your business occupy?)
- What is the total sale price of the property?
- Do you plan to invest in renovations after buying? If so, how much will you need for that?
- Are revenue-generating tenants already in the property? If so, how much do you expect to start collecting on day one?
Step 3: Apply for the loan
Depending on the type of lender and loan you choose, you may be able to apply online, over the phone or in person. Regardless, you will need to be prepared to submit the information listed above to initiate your loan application.
Your lender will then review your application, send an appraiser to evaluate the property and request supporting documentation (if necessary) before informing you of their decision. Again, depending on the type of loan you choose, this could take anywhere from a week or two to as long as three months.
After approval, your lender will fund your loan, less any origination fees and appraisal fees outlined in the fine print of your loan agreement. Once your loan has been funded, you’re free to begin work on your new property.