Are you looking to expand your business to a new city? Need a better office building that can handle your company’s growth? Perhaps you want to refinance your current warehouse or rent new servers. When it comes to business-related real estate, whether to rent out or occupy, your company will need to investigate commercial real estate loans, financing options designed specifically for businesses looking to purchase or refinance a property.
When it comes to commercial real estate loans, there are some key differences from residential.
Commercial real estate (CRE) can range from purchasing large office buildings and renting out the space to purchasing land or financing equipment. How you plan to run your investment and your company’s financial status will affect what type of loan works best.
Breaking Down Loan Categories
There are six types of commercial loans:
- Conventional Commercial Loans— fixed-rate mortgages generally from banks
- Commercial Bridge Loans— short-term loans until the investor secures permanent financing
- Hard Money Loans— short-term loans from private companies
- Small Business Administration Loans— SBA loans are government-backed to help small business entities
- Small Balance Commercial Loans— designed for smaller commercial real estate, with flexible terms and simple underwriting
- Non-QM Investor Loans— outside the rules of a qualifying mortgage, commercial loans for residential properties
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SBA loans are government-backed, so they have higher restrictions on who can apply. The lower interest rates help small businesses when other lenders aren’t willing to take the risk. SBC loans are pickier on what they can cover, often requiring office or light industrial space to have plants for multiple tenants.
Qualifying for Commercial Real Estate Loans
Commercial lenders still look primarily at cash flow, but commercial loans benefit from high debt-service coverage ratios alongside good credit scores (660+). You may also need to turn in more documentation than you would for a residential loan. However, loan terms are more flexible.
Because these loans are for businesses, lenders do have three key requirements:
- Security— This generally looks like 25 to 30% in equity; for new purchases, this looks like a 25% or more down payment. Your lender will likely require property insurance, as well.
- Income— You need to have a good DSCR, or debt-service coverage ratio. This helps lenders have confidence in your ability to pay the loan and shows your experience as a business owner.
- Credit— lenders need to assess your credit risk when they consider lending to you. They may look at both your business and your personal credit score, or they may just use the businesses. The lowest score most lenders will consider is 660; some won’t go below 680.
Commercial loans have different requirements for collateral and underwriting and may also offer varying rates and terms. Like with residential loans, you should compare what different lenders are willing to offer your business.
Commercial Loans vs. Residential
In addition to qualification requirements, loans for business entities have other key differences from individual loans. For one, commercial loan terms generally range from 5-20 years rather than the 15, 25, and 30-year options for residential. The amortization period often extends past the terms, as well, rather than running parallel. The length of the loan and the amortization period will affect your terms, so don’t hesitate to price out different lengths.
Next is LTV consideration. Residential loans allow for more variance in Loan-to-Value ratios, whereas most businesses will fall between 65-80%. Commercial entities also cannot access VA or FHA loans; lenders must rely on collateral for security.
Finally, Interest for commercial real estate loans is often higher, and there may be additional fees. Some costs may be required upfront before the lender will consider your qualifications.
Investing in CRE
When a real estate business invests in CRE, they are planning to lease the property to other businesses or to multiple families. Some real estate businesses focus on office and industrial spaces, while others lean towards apartment buildings with multiple tenants. While these investors see the need for significant capital upfront, the returns are far and above what vacation rental property owners may see. CRE investors also tend to use longer leases with long-lasting tenants.
However, like all investments, there are risks. You may be subject to heavy government oversight, complicated taxes, and more. You may also have a harder time filling vacancies, as tenants have more to commit to. Finally, renovations may require massive expenses. You will need to foot the bill for any major repairs, changes, or upgrades.
With all that in mind, commercial real estate can see massive appreciation if there is a low turnover of tenants, regular upkeep, and low vacancies. CRE is also safer than investing in stocks, as the stock market is often highly volatile— real estate is better for building wealth.