If you’ve done your research and decided that commercial real estate is right for you then it’s time to get financing organized. There are several financing options available, and you will need to decide which one makes the most sense for you.
Commercial Real Estate Financing 101
If you will be financing your commercial real estate investment, it’s important to know your loan options and what information you will need to provide in order to get approved. Each type of loan has specific eligibility requirements and varying terms so you will need to decide which type of loan makes the most sense for you. Lenders will typically make their decisions based on an investor’s financial and credit history.
Here are some basics for getting a commercial real estate loan:
- Decide if you will be financing a commercial property as an individual or as a business entity such as a corporation, developer, or business partnership.
- You will need a favorable loan-to-value (LTV) ratio for approval. The LTV ranges from 65 to 80 percent for commercial loans, with lower LTVs qualifying for more favorable financing rates.
- You will need a favorable Debt Service Coverage Ratio (DSCR) that shows the property’s ability to service debt. Commercial lenders are usually looking for DSCRs of at least 1.25 to ensure proper cash flow; anything less than one percent reveals a negative cash flow.
- Consider what type of commercial real estate property you would like to purchase and whether you plan to keep the property long-term or sell it for a profit after renovations as this will affect the type of loan that you should pursue.
Here are the main commercial loan options:
Conventional commercial real estate loan
A conventional commercial real estate loan is issued by a bank or lending institution and it isn’t backed by the federal government. Banks may offer several different types of conventional commercial real estate loans. The main advantage of a conventional commercial mortgage is that it has no maximum loan size.
On the other hand, because conventional commercial real estate loans can be quite large and aren’t government-guaranteed, the qualifications are stricter. Borrowers need a minimum credit score of 700 and some lenders require applicants to have been in business for up to five years. You can safely expect that the larger the loan requested, the stricter the financial and credit requirements will be.
Other costs and terms:
- Interest rate of 5% to 7%, variable or fixed
- Minimum down payment of 20% to 35% of the purchase price
- Five to 25-year loan term
- LTV Ratio of 80%
- Closing costs of 2% to 5% of amount borrowed
- Lender fees of up to 1% of amount borrowed
- Funding speed of 30-45 days
Commercial bridge loan
A commercial bridge loan is used for short-term financing for the purchase of commercial real estate, with extra money built in to restore the property. In some cases, commercial real estate investors who don’t qualify for permanent financing will turn to a bridge loan.
Commercial bridge loans are based on the loan-to-cost (LTC) ratio or after-repair-value (ARV), rather than the LTV ratio. There is higher risk to the lender because they are basing the value of the property on its future value (after repairs). In exchange, these loans often come with a higher interest rate than permanent financing.
Investors with property renovation experience may have an edge when it comes to commercial bridge loans.
Other costs and terms:
- Interest rate of 6% to 10%
- Maximum loan amount of $40 million or higher
- 12 to 36-month loan term
- Minimum down payment of 10% to 20%
- LTV ratio of 75% of final value
- Closing costs of 2% to 5%
- Exit fee of 1%
- Funding speed of two to five weeks
CDC / SBA 504 Loan
A Certified Development Company (CDC) / SBA 504 loan has two parts, with both closing at the same time. The first part comes from a traditional lender and the other part comes from a nonprofit lender known as a community development corporation (CDC). Similar to SBA 7(a) loans, you can go up to 90% LTV on an SBA 504 loan, which reduces the amount of cash required for the down payment.
Some things to consider are that there are very strict requirements for SBA 504 loans and it can take two or more months for these loans to close.
Other costs and terms:
- Interest rate of 2.5% to 3% fixed on the CDC portion and 4% to 10% on the lender portion
- Maximum loan amount of $14 million
- SBA guarantee fee of approximately 1%
- Up to 25-year term
- Minimum down payment of 10% to 20%
- LTV ratio of 90%
- Lender fees:
o 0.375% to 0.4% underwriting fee
o Up to 1.5% processing fee
o $2,000 to $5,000 legal fee
o 0.25% funding fee
o 0.5% guarantee fee
- Funding speed of one to two months (or more)
Commercial hard money loan
Hard money loans are a type of short-term commercial real estate loan, typically used by businesses that can’t get funding from other traditional lenders either because of credit issues or properties in very poor condition. This type of loan isn’t ideal because of high interest rates and fees but it does have very fast funding times.
Other costs and terms:
- Interest rates starting at 6.5%
- Maximum loan amount of $3 million
- One to four-year term
- Minimum down payment of 15% to 35%
- 90% LTC, 75% ARV
- Closing costs as low as $999
- Lender fees of 1.5% to 2% of loan amount
- Funding speed of five to 15 days
Small Business Administration (SBA) 7(a) loans
Small Business Administration (SBA) 7(a) loans are desirable commercial real estate loans because of their low interest rates and up to 90% loan to value (LTV), which reduces the amount of cash required for a down payment. One thing to consider is that there is a prepayment penalty for loans with a term of 15 years or greater that kicks in for borrowers who prepay more than 25% of their loan back in the first three years.
If you can meet the many requirements of this type of loan and plan to hold onto your investment after renovations, an SBA loan is worth considering.
Other costs and terms:
- Interest rate of 4.75% to 7%
- Maximum loan amount of $5 million
- SBA guarantee fee of 2% to 3.5%
- Terms up to 25 years
- Minimum down payment of 10% to 30% of purchase price
- LTV ratio of 90%
- Closing costs in the amount of $5,000
- Lender fees of 1% to 5% of loan amount
- Funding speed of 30 days
Ready to get started
When deciding on which type of commercial real estate loan to pursue, it’s important to choose the loan that is suited to the type of property you want to purchase, what you intend to do with the property once it’s renovated, and whether you meet the requirements. You will also want to consider the pros and cons of each type of commercial real estate loan, including interest rates, fees, and term lengths.
Once you have done your research and secured financing, you’re ready to start investing!
Turn to Windermere for real estate done exuberantly right.
For 50 years, Windermere has used our extensive knowledge of local markets to offer a full range of services that match your commercial real estate needs. Whether you’re a business looking to buy or lease space, or an investor interested in private capital or institutional properties, you’ll benefit from our experience in all phases of commercial real estate, including leasing, business development, brokerage, property management, and consulting.
You can depend on our powerful network
Windermere Commercial has established connections with highly reputable brokers throughout the nation. We also have the benefit of being affiliated with Windermere Real Estate, so you aren’t simply hiring a broker; you’re hiring an entire company with an extensive team of dedicated professionals whose highest priority is to help you reach your commercial real estate goals.
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