Commercial Real Estate Loans: How They Work and Where to Apply

All you need to know about commercial real estate loans—all in one guide.
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Commercial Real Estate Loans: Everything You Need to Know

Commercial real estate loans are business funding options that allow business owners access to capital specifically for purchasing commercial real estate, renovating commercial real estate, or doing both. The property that a borrower purchases or improves with the proceeds of a commercial real estate loan will, in turn, act as collateral for that very loan.

The top five types of commercial real estate loans are:

  1. Traditional commercial real estate loans from banks
  2. SBA commercial real estate loans
  3. Commercial bridge loans
  4. Hard money loans
  5. Commercial real estate crowdfunding

There are a lot of business real estate loans options, and finding the right one can determine how successful your commercial real estate project turns out. Your choice will also impact how much time you spend on applying and on paperwork versus how much time you have to invest in your property. Learn the ins and outs of commercial estate loans and how to find the best mortgage for your business.

Commercial Real Estate Loans: The Top 5 Options

Commercial real estate is any kind of property that you use for business purposes. The term could refer to a brick and mortar stores, shopping malls, office buildings, or manufacturing facilities. Land or mixed-use properties like multifamily apartment buildings are also commercial real estate.

If you have plans to purchase new or existing commercial properties, or to renovate commercial space, you can take out commercial real estate loans—often referred to as a business mortgage loan—to help finance the project. The property itself serves as the collateral for the loan.

Commercial real estate loans definitely aren’t one size fits all. There are several types, varying in terms, loan amounts, eligibility requirements, length of the commercial loan application process, commercial real estate loan rates, and potential fees. Whether you’re aiming to make a real estate purchase or refinance pre-existing commercial real estate debt, here are the top five options:

1. Traditional Commercial Real Estate Loans

A traditional commercial real estate loan comes from a bank. It’s what first comes to mind for most people when they think of commercial real estate financing. Banks normally lend the most amount of money, at the lowest cost. But, they’re also hard to get. Bank commercial real estate loans are typically reserved for the most creditworthy borrowers and for businesses that have been showing a profit for at least a couple years.

2. SBA Commercial Real Estate Loans

The SBA has two loan programs that can be used for real estate: the 7(a) and the 504 loan program. The 7(a) program is a general purpose business loan that you can use for many different business reasons, including buying and repairing commercial property. The term is 25 years for real estate, and rates are in the range of 7% to 9.5%.

But for the biggest savings, apply for an SBA 504 loan. 504 loans help small businesses purchase and upgrade capital-heavy assets, such as commercial real estate and equipment. A bank and SBA-approved non-profit lender work together to provide financing. The best parts of the 504 loan are the lengthy terms (20 or 25 years) and some of the lowest fixed rates around (starting 5%).

3. Commercial Bridge Loans

A commercial bridge loan is a short-term commercial loan that lets you quickly buy property or capitalize on an opportunity. When the loan reaches maturity, you either have to pay off the commercial bridge loan in full, or more commonly, refinance it into a long-term financing. These loans “bridge the gap” between identifying property that you want to buy or renovate and finding affordable, longer-term financing. Bridge lenders can be banks or alternative lenders.

4. Hard Money Loans

Hard money commercial real estate loans are short-term loans from private lenders and investors. Compared to banks, hard money lenders tend to loan smaller loan amounts, and also charge higher interest rates. But in exchange, qualifying for a hard money loan tends to be much easier than qualifying for a bank loan. In fact, many younger small businesses get their first few commercial real estate loans from hard money lenders.

5. Commercial Real Estate Crowdfunding

The latest entry to the commercial real estate loan space are crowdfunding platforms. With crowdfunding platforms, many people lend small amounts of money to your project. When added together, these small loans equal out to one big commercial real estate loan. Real estate crowdfunding platforms are similar to other short-term options in terms of cost and terms.

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How Commercial Real Estate Loans Work: Terms, Loan Amounts, and Rates

Many people assume that a commercial real estate loan (also called a commercial mortgage) is similar to a residential mortgage. But that’s not really true. As you now know, there are many types of commercial real estate loans, each a little bit different. And since commercial real estate secures the loan, this self-collateralized nature of the funding affects terms, eligibility, and other factors.

Now for the nuts and bolts of commercial real estate loans: commercial lending terms, interest rates, and fees.

Commercial Real Estate Loan Repayment Terms

A residential mortgage can come in two garden varieties—a 15-year term and 30-year term. But, commercial loan real estate terms are all over the map depending on which type of loan you opt for.

SBA loans and bank loans are usually fully amortized commercial real estate loans with 20- to 25-year terms. That means you make payments in monthly installments. Initial payments go towards interest, but as you pay more, payments go towards the principal balance.

Hard money and crowdfunded loans are much shorter-term loans with repayment terms ranging from one to five years long. Since these options are so short-term, they’re good for investment opportunities like fix and flips where you buy and dispose of the property within a short period of time. These loans can also work as construction loans and renovation loans when a bank won’t work you.

These commercial real estate loans have the shortest terms of all, usually under one year. When the term is up, you either to pay off the loan or refinance.

Commercial Real Estate Loans With Balloon Payments

Many short-term commercial real estate lenders offer “balloon loans” with a 5- to 7-year term. A balloon loan has low interest-only payments throughout the term, and the full balance is due at the end in one big “balloon” payment.

With balloon loans, there are fixed monthly payments throughout the term, but those payments don’t cover the entire commercial loan repayment.

The monthly payments are calculated as if the loan is a traditional 25- or 30-year mortgage.

But and at the end of your 5 or 7-year term, you’ll have paid off only interest and perhaps a small portion of your principal balance—the rest that you owe is due all at once.

If you’re considering a balloon commercial real estate loan, the last payment will be very high, and your budget should be ready for it. You should only commit to a balloon loan if you know you’ll have the cash on hand when it comes time to make the final payment.

Otherwise, you’ll have to refinance your business mortgage or sell your business property to make the balloon payment.

Commercial Real Estate Loan Amounts

Commercial real estate projects can cost a relatively small amount, or they might go up to seven figures.

The maximum loan amount you’ll be able to access for your commercial real estate loan depends on two factors:

  1. The purchase price of the property you are buying or renovating
  2. The type of lender you are working with

Let’s look at how both of these things affect loan size.

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Commercial Real Estate Loan-to-Value (LTV)

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 90% LTV ratio, whereas short-term commercial real estate lenders usually lend only 50% or 60% LTV. Whatever the commercial real estate loan doesn’t cover, the borrower has to bring as a down payment.

Say you’re purchasing a $200,000 piece of property. Banks might lend up to $180,000 for good 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 down payment, the more skin you have in the game—and that usually means you’ll have a lower your interest rate attached to your commercial real estate loan. For instance, if you offer to put a higher down payment on a loan, then you might qualify for a lower interest rate. But across lenders, a bank will always be more affordable than a short-term commercial real estate lender.

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Commercial Real Estate Loan 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.

Commercial Real Estate Loan Interest Rates

As with any small business loan, the actual interest rate you get on your commercial real estate loan depends on your type of business, its financial health, and your creditworthiness.

In general, commercial property finance tends to come in at a steeper price point than a residential mortgage. This is because businesses are just riskier to lend to than people, and there’s more volatility in commercial real estate values.

However, the good news is that business real estate loans tend to be more affordable than other types of small business loans because the property secures the loan.

You should also know that your commercial real estate loan interest rate will depend on the kind of real estate financing company you work with. Banks tend to charge the most competitive rates, starting at 5%. Short-term lenders might charge anywhere from 10% to 30%.

A commercial real estate loan will either come with a fixed or variable rate. A fixed rate will stay the same over the entire life of the mortgage, but a variable rate will change with the market.

Commercial Real Estate Loan Fees

Apart from interest rates, fees also impact the cost of your commercial real estate loan. Most commercial real estate loans have fees that you’ll need to pay before you take on the loan.

You have to pay some of these fees during the underwriting process, whereas others you can bundle into the loan.

You pay the application fee when you submit your application, and origination fees usually come out of the top of the loan. Origination fees usually range from 1% to 2% of the total loan amount. Then, there are often property appraisal fees, legal costs, survey fees, and so on. Sometimes, there are also small annual fees.

You should also be aware of any prepayment penalties on your commercial real estate loan You could have a typical prepayment penalty, but there could also be an interest guarantee, defeasance, or lockout restricting you from paying early. In each of these cases, the lender benefits the longer you hold onto your loan, or they mandate a certain level of profit at the outset.

Before committing to your commercial real estate loan, ask any potential lending partners to clearly explain any and all fees that will impact your total borrowing cost. This way, you can avoid unpleasant surprises down the line.

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How to Qualify For Commercial Real Estate Loans

When you’re out searching for a mortgage for commercial real estate, you’ll likely wonder which options are best for your business’s credentials.

Commercial real estate loan requirements—as with any business loan—vary based on who you’re working with. But since commercial real estate is such a large, capital-intensive investment, lenders look especially closely not just at you, but at the property you want to purchase as well.

Here’s what lenders will consider when you submit an application for a commercial real estate loan.

Your Credit Score

As with other types of small business loans, the commercial real estate loans you can qualify for 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.

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 set a minimum bar for credit scores at around 550.

If your credit score is 700 and higher, you’ll have the most desirable commercial real estate loans available to you—like an SBA loan and a traditional mortgage from a bank. Long story short? Be sure to pay down that credit card balance before you apply for a commercial real estate loan.

Real Estate Collateral Value

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. Some lenders base the maximum loan amount they’ll approve you for based on the ARV.

Time in Business

As with other small business lenders, commercial real estate lenders will also look at your time in business before approving your commercial real estate loan. It’s a simple thing to look at, but it has significant implications on what your business qualifies for.

Put simply, the younger your business is, the riskier your business is for a lender. The owner of an established business has proven that they can weather the ups and downs that come with running a small business. That gives the lender more certainty that the owner will be able to pay back the loan.

A business that has been operating for at least two years has the best chance of qualifying for commercial real estate loans.

The lender could also look at your previous management experience before issuing you a commercial real estate loan. Having a lot of experience running and growing a business—perhaps even a proven track record in expanding to new locations or renovating a commercial space—will help prove that you’re a good candidate for the loan.

Debt Service Coverage Ratio

Commercial real estate loans are large loans that can have a significant impact on your business budget For this reason, lenders want to be fairly certain that you have the financial capacity to pay off the loan comfortably.

One way to prove that you have enough cash assets on hand to pay off the financing is to look at your debt service coverage ratio, or DSCR. 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. 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. That means 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.

Lenders usually look for a DSCR that’s greater than 1.2 when evaluating your commercial real estate loan qualifications.

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Commercial Real Estate Loans: Where to Get Them

With so many different options, where should you go for your business real estate loan? This is going to depend on your creditworthiness and the type of property and project you have in mind.

The most creditworthy business owners should start with their local bank or credit union for  affordable, long-term loans. The local bank might suggest an SBA loan or traditional commercial lending, if you’ll qualify. You can also try a bank like Wells Fargo or Chase that have strong small business lending programs.
If you aren’t the most creditworthy, then you can start out with short-term commercial real estate lending. Short-term commercial real estate financing lenders will vary by location, but the Scotsman Guide has a state-by-state directory. Popular crowdfunding platforms include RealtyShares and RealtyMogul.

How to Apply for Commercial Real Estate Loans: Document Checklist

Applying for a commercial real estate loan can be paperwork-intensive. If you go through a bank, expect the document list to be especially long and detailed. While short-term options don’t have as many commercial real estate loan requirements, but there are still some basic documents you need to have in order.

Here’s some essential paperwork to gather for your commercial real estate loan.

Business Owner Information

  • 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

  • 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

Personal Financials

  • 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

Business Financials

  • Project budget
  • Sources of revenue while construction or renovation is underway
  • Projected business revenues and profits for the next 3 to 5 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 & Accounts Receivable Aging Report
  • Rent roll (if the property is a rental property)
  • Lease (if the property is a rental property)

Construction or Renovation Phase

  • 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

Commercial Real Estate Loans: The Bottom Line

As with any business loan, make sure you shop around for multiple offers from different commercial lenders. Your commercial real estate loan will be with you for the long haul, so you should be confident that you’re getting the best terms and rate for your business.

Once you’ve found a good fit for your business, you’re well on your way to getting the real estate you need to take your business to the next level.

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