Commercial Real Estate Loans Overview
If you’re looking for capital to purchase or renovate real estate, then you’ll want to narrow down your search for business loans.
With commercial real estate loans, you can access financing for this specific purpose—plus, the property that you purchase or improve with the proceeds will, in turn, act as collateral for that very loan.
So, how do commercial real estate loans work? What are the best options for financing commercial property?
In this guide, we’ll answer those two questions—plus, we’ll explain commercial real estate loan rates, terms, and amounts, how to qualify, and how to apply—so that you have all the information you need to decide what’s right for your business.
The Ultimate Guide to Commercial Real Estate Loans
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 business mortgage loan) designed specifically for the purposes of purchasing 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, shopping mall, office building, or manufacturing facility. Land or mixed-use properties like multifamily apartment buildings are also considered commercial real estate.
Learning how to get a commercial real estate loan is similar to equipment or invoice 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 loans definitely aren’t one-size-fits-all. There are several types, varying in terms, rates, loan amounts, eligibility requirements, length of the application process, and potential fees.
Types of Commercial Real Estate Loans
So, with this overview in mind, let’s discuss some of the different types of commercial real estate loans.
Whether you’re aiming to make a real estate purchase or refinance pre-existing real estate debt, these five options are worth considering:
Traditional Bank Loans
First, you might consider the most traditional type of commercial real estate loan, a bank loan.
A bank loan is often what people think of when it comes to commercial real estate financing.
As is the case with the majority of business bank loans, banks will be able to lend you the most amount of money for your commercial real estate needs, at the lowest cost. Bank will also be able to offer the longest terms on your loan.
Most big banks, like Wells Fargo, Bank of America, and U.S. Bank will have a specific real estate lending program. Within their commercial real estate financing division, for example, Wells Fargo offers four products, including a commercial real estate purchase loan—with amounts ranging from $50,000 to $1 million, no application or appraisal fee, and a variety of term options.
Overall, banks will provide the most desirable commercial real estate loans, but they’ll also be difficult to qualify for. Generally, you’ll need a high credit score and strong business financials to qualify for a commercial property loan from a bank.
Next, you might look to the SBA for some of the best commercial real estate loans. After banks, SBA loans will offer the most desirable terms and rates and will be easier to qualify for (although still will require high-level qualifications).
This being said, the SBA has two loan programs that can be used for real estate: the 7(a) and the 504/CDC loan program.
SBA 7(a) Loans
The SBA 7(a) program is a general-purpose business loan program, offering loans that can be used for a variety of purposes, including buying and repairing commercial property.
These loans can reach $5 million in funding, terms up to 25 years, and interest rates from approximately 7% to 9.5%.
SBA 504/CDC Loans
For the biggest savings, however, you can apply for an SBA 504/CDC loan. These loans help small businesses purchase and upgrade capital-heavy assets, such as commercial real estate and equipment.
A bank and SBA-approved nonprofit lender (CDC) work together to provide financing. SBA 504/CDC loans have terms of 20 or 25 years, amounts up to $5.5 million, and low interest rates ranging from 4% to 7%.
You may also consider a commercial bridge loan for your commercial real estate financing needs.
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 loan in full or, more commonly, refinance it into 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.
Hard Money Loans
Another option to keep in mind for commercial real estate financing is a hard money loan.
Hard money loans are short-term loans from private lenders and investors that are backed by tangible assets, most often real estate and property. Compared to banks, hard money lenders tend to offer smaller loan amounts and also charge higher interest rates.
In exchange, qualifying for hard money business loans tends to be much easier than qualifying for many other types of loans. In fact, many younger small businesses get their first few commercial real estate loans from hard money lenders.
Nevertheless, because of the possible high costs and risks associated with these commercial real estate loans, you’ll likely want to see if you qualify for other products before turning to hard money loans.
Finally, you might consider short-term business loans from online lenders as a top option for commercial real estate financing.
Although these loans can be used for a variety of purposes, they’re generally fast to fund and easy to qualify for—making them great alternatives for business owners who can’t access bank or SBA funding.
Short-term loans can range in amounts from $2,500 to $250,000 with terms from three to 18 months. Interest rates on these commercial property loans will be higher than some other options, with rates often starting at 10%.
This being said, however, many short-term loans can fund in as little as one day and you can often complete your application online with limited documentation. Online lenders who offer these products are also more likely to accept business owners with bad credit or new businesses.
How Commercial Real Estate Loans Work
Now that you have a better understanding of the best types of commercial real estate loans, let’s explain in more detail exactly how these products work.
Many people assume that a commercial real estate loan is similar to a residential mortgage. In reality, commercial property loans are very different, and since the real estate or property itself secures the loan, this self-collateralized nature of the funding affects terms, eligibility, and other factors.
Let’s learn more.
A residential mortgage can come in two garden varieties—a 15-year term and 30-year term. Unlike residential mortgages, commercial loan real estate terms can fall within a wide range 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. With these loans, you would make payments in monthly installments, your initial payments would go toward interest, and as you paid more, then payments would go toward the principal balance.
Hard money loans will have much shorter terms with repayment terms ranging from one to five years long. Since these options are so short-term, they’re best suited for investment opportunities like fix and flips, where you buy and dispose of a property within a short period of time. These loans can also work as construction loans and renovation loans when you can’t qualify for bank funding.
Bridge loans, like online short-term loans, will have the shortest terms of all, usually under one year. When the term is up, however, you need to either pay off the loan in full or refinance.
Another important feature to review with regard to commercial real estate is balloon payments.
Many short-term commercial lenders offer “balloon loans” with five- to seven-year terms. A balloon loan has low interest-only payments throughout the term (month-to-month), and the full balance is due at the end in one big “balloon” payment.
This being said, if you come across a commercial real estate loan with a balloon payment setup, you’ll want to remember that the last payment will be very high, and you’ll need to prepare your budget accordingly. In this way, 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, if you can’t make the final payment, you’ll have to refinance your business mortgage or sell your business property.
Commercial real estate projects can call for relatively small loan amounts or they might call for amounts with seven figures.
This being said, the maximum amount you’ll be able to access for your commercial real estate loan will depend on two factors:
- The purchase price of the property you are buying or renovating
- The type of lender you are working with
Let’s look at how both of these factors affect loan size.
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.
Now, you’re probably wondering: What are commercial real estate loan rates? As with any small business loan, the actual interest rate you receive 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 riskier to lend to and there’s more volatility in commercial real estate values.
However, business real estate loans also tend to be more affordable than other types of small business loans because, as we’ve mentioned, the property itself secures the loan.
This being said, commercial real estate loan rates will ultimately 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%.
Additionally, commercial real estate loans will either come with a fixed or variable interest rate. A fixed-rate will stay the same over the life of the mortgage, but a variable rate (per the name) will change based on the market rates.
Our commercial real estate loan calculator will help you better understand how much you owe and your repayment terms.
Apart from interest rates, fees will also impact the overall 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.
Some of these fees must be paid during the underwriting process, whereas others you’ll be able to bundle into the loan. An application fee, for example, will be paid when you submit your commercial loan application and origination fees will come out of the top of the loan. Origination fees usually range from 1% to 2% of the total loan amount. Additionally, there are often property appraisal fees, legal costs, survey fees, and more depending on your loan and lender.
Moreover, you’ll want to be aware of any prepayment penalties on your commercial real estate loan You could have a typical prepayment penalty (aka a penalty for paying your loan off early), 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.
Therefore, before committing to your commercial real estate loan, you’ll want to ask any potential lending partners to clearly explain any and all fees that will impact your total borrowing cost.
How to Qualify for Commercial Real Estate Loans
So, now that we’ve gone through how commercial real estate loans work, and the best options, you may be wondering how you can qualify for this type of business financing.
Ultimately, commercial real estate loan requirements—as with any business loan—vary based on who you’re working with. However, since commercial property is such a large, capital-intensive investment, lenders will not only look at you and your business, but also at the property you want to purchase or renovate 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 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.
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.
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—giving the lender greater certainty that the owner will be able to pay back the loan.
Generally, a business that has been operating for at least two years has the best chance of qualifying for commercial property loans.
Along these lines, a lender may also look at your previous management experience before issuing you a loan. Having 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
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)
Use our guide for more information on how to get a commercial loan.
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 conventional bank or SBA loans, 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.
Meredith Wood is the founding editor of the Fundera Ledger and a vice president at Fundera.
Meredith launched the Fundera Ledger in 2014. She has specialized in financial advice for small business owners for almost a decade. Meredith is frequently sought out for her expertise in small business lending and financial management.