10 min read

Everything You Need to Know about Loans on Commercial Properties

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The commercial real estate market in the United States has substantial growth potential, with projections indicating a market value of $28.18 trillion by 2028. However, buying a commercial property, whether a shopping center or an office building, requires considerable funding. 

Commercial real estate loans are a solid financing option for those who can’t afford a hefty down payment for property acquisition or need significant capital to cover business expenses. Sounds impressive, right?

Read on to learn all about loans on commercial properties, their different characteristics, and the associated fees and rates.

What is a Commercial Real Estate Loan?

As the name implies, a commercial real estate loan is a mortgage secured by a lien on commercial or income-generating properties. These properties range from a quaint bakery in a village and a mid-sized industrial warehouse to office towers.

Besides buying property, business owners also use this amount for the following purposes:

  • Construction and development: If you own land and see potential in it, you can use the load proceeds to build a new structure from the ground up. 
  • Space expansion: When your current commercial space becomes too small for your growing business, these funds can help you acquire additional space and expand your operations. 
  • Renovation: A commercial real estate loan can provide the capital to revamp and modernize outdated facilities. This will increase their value and ensure compliance with existing rules and regulations.
  • Purchase equipment: Sometimes, business success depends on having the right tools. Whether it's manufacturing machinery, restaurant ovens, or office supplies and furniture, this loan can cover the costs so your company maintains its competitive edge.
  • Support working capital: There are occasions when cash flow is tight, and obligations like payroll, utilities, or inventory must be met. This loan helps keep the day-to-day operations running smoothly. 
  • Pay existing debts: If you’re carrying a substantial debt, it can cause financial and emotional strain. However, you can use this loan to consolidate and pay off those debts, ultimately reducing financial pressure and allowing you to focus on growing your enterprise.

Commercial Loans vs. Residential Loans — The Big Difference

Most people are somewhat familiar with the concept of residential mortgages. These loans are used to buy houses or apartments that eventually become our homes. While both serve as a means to finance property, the differences between commercial real estate loans and residential loans are significant. 

For clearer insight, take a look at the table below:

Commercial Real Estate Loans

Residential Loans

These loans are made to business entities like corporations, developers, partnerships, funds, trusts, and real estate investors.

These loans are intended for individuals and families intending to buy or refinance their homes.

They have a loan term of 5 to 20 years but often include a balloon payment if the entire balance is not repaid at the end of the term.

A typical residential loan term is 15 to 30 years, allowing for steady amortization over time.

Since commercial loans have increased perceived risks, they require a sizeable down payment. Usually, the LTV ratio of commercial loans caps between 75% to 80%.

These loans usually have a higher LTV ratio of up to 95%. However, loans above 80% LTV may require private mortgage insurance (PMI).

Types of Commercial Real Estate Loans

Depending on the type of property you want to purchase, you can apply for the following types of commercial real estate loans:

Bank Loans

Bank loans refer to the funds your local or national banking institution or credit union provides to purchase commercial property or renovate an existing one. Different financial institutions have different requirements, but the basics remain the same. 

Ideally, you should have a steady net income and solid credit score. For instance, if you have a credit score of 680 or above, you may qualify for lower interest rates. However, if your credit score doesn’t fall in this range, you can counterbalance it with business experience and stable annual revenue.

SBA Loans

Backed by the Small Business Administration, SBA loans make it easier for small businesses to get capital for commercial properties like office buildings, retail stores, warehouses, manufacturing facilities, and hotels. 

SBA-guaranteed lenders also provide impressive incentives. These include competitive interest rates and flexible repayment terms compared to traditional banks. However, loan approval depends on the business income, operation location, and credit history.  

There are two main types: the 7(a) loan and the 504 loan. Each has its perks, depending on what you need the money for.

Loan Type

SBA 7(a) Loans

SBA 504 Loans

Loan Proceed Usage

This type of loan can be used to buy and renovate commercial real estate, pay current business debt, get working capital, purchase machinery and supplies, and change business ownership

This loan can only be used to purchase land, buildings, or machinery and construct or renovate existing facilities, utilities, parking lots, and landscapes. 

Maximum Loan Amount

Up to $5 million

Up to $5 million for major fixed assets

Interest Rate

11.5%-15%

6.55%-6.86%

Repayment Terms

Up to 7 years for working capital, 10 years for equipment, and 25 years for real estate

Variable maturity terms of 10/20/25 years

The only downside? Suppose you own a non-profit business or life insurance company or are involved in speculative real estate investments, lobbying activities, or pyramid sale distribution plans. In that case, you are ineligible for SBA loans. 

Bridge Loan

Designed to "bridge" the gap when immediate funds are needed but not yet available, these loans are short-term financing solutions (lasting from a few months up to a year) used in various scenarios. 

Consider this: you’re looking for a commercial space, but your current property hasn't sold yet. In that case, you can get a bridge loan from financial institutions to secure that new property until your sale goes through. 

Keep in mind that this speed and convenience come at a cost. Bridge loans typically have higher interest rates than traditional loans, ranging from 0.5 to 2% per month.

Hard Money Loans

A hard money loan might be worth considering if you don’t qualify for a traditional bank loan or have the time to go through the lengthy approval process. Known for their speed of approval and flexible terms, private investors or companies typically provide hard money loans to secure a commercial property quickly, renovate it, and either sell it for a profit or refinance it with a more traditional loan.

Despite the benefits, there are trade-offs:

  • Compared to bank loans, hard money loans have higher interest rates with short repayment terms of 1 to 5 years.
  • They also tend to be non-recourse, which means that if things go wrong, your assets aren't on the line—just the property itself.

Blanket Loans

A blanket loan allows real estate investors to finance multiple properties with a single lender under a single mortgage, so you don’t have to juggle several loans with various rates and payment schedules.

While this unified approach streamlines the process and possibly saves money over the investment term, it comes with a catch. If you run into financial trouble and default on a blanket loan, all the properties secured by the loan could be at risk, not just one. 

Similarly, these loans often involve a release clause that outlines conditions for selling a part of the collateral, which might require paying down a significant portion of the loan or renegotiating terms.

Commercial Properties Loan Qualification Criteria

Regardless of the lender you choose, you must meet specific qualification criteria to secure a loan for commercial properties. This includes:

Credit Score

Your credit score is a reflection of your creditworthiness. Lenders use this to indicate how reliably you can manage loan repayments. According to the FICO model, credit score falls into 5 categories that explain your financial standings:

  • Poor (300-579)
  • Fair (580-669)
  • Good (670-739)
  • Very Good (740-799)
  • Exceptional (800-850)

The higher your credit score, the better your chances of securing favorable loan terms. When getting loans for commercial properties, a credit score of 700 or above is typically considered good, although some lenders may work with lower scores. 

Collateral

Collateral is the property or assets you pledge as security for the loan. In commercial real estate, the property being financed usually serves as collateral. If the loan is not repaid, the lender can seize the property to recover the loan amount, while your assets, like residential buildings, valuables and collectibles, vehicles, and savings accounts, remain unaffected.

Minimum Loan Amount

Some lenders set a minimum loan amount for commercial property loans according to their target market and operational capabilities. This figure could be anything from $250,000 to $500,000 or even higher. 

For instance, if you need a loan of $150,000 for commercial renovation, you may not fulfill the lender’s criteria. In that case, you may need to explore alternative funding sources such as regional banks, credit unions, or specialized loan programs.

Loan-to-Value Ratio

LTV compares the loan amount to the property's appraised value and determines how much down payment you need. For example, if a lender offers an LTV of up to 80%, they will cover up to 80% of the property’s value, leaving you to provide the remaining 20% as a down payment. Lenders set LTV limits to manage their risk; the more you invest upfront, the lesser the risk.

Debt Service Coverage Ratio

The DSCR measures your property's ability to generate enough income to cover the debt payments.

To calculate DSCR, divide the property’s annual net operating income by its total debt service for the year. Generally, lenders look for a DSCR of 1.25 or above, which indicates the property's income is 25% greater than its debt expenses. 

This also guarantees lenders that you can still repay loans without defaulting, even if you encounter an issue.

How To Apply for Commercial Property Loans

Getting a loan on commercial properties can be confusing, especially if you’re unprepared. Here’s a step-by-step process to apply for CRE loans:

  1. Different commercial property loan lenders have different requirements and payment terms, so you must compare them and choose one that best fits your investment strategy and financial situation. Some lenders even provide assumable loans, allowing you to sign the mortgage to a qualified buyer if you plan on selling the property.
  2. Commercial loans often require property appraisals and environmental checks to identify the property’s value and potential liabilities. Be proactive and prepare an assessment report to expedite the application process.
  3. Calculate your DSCR using the following method and ensure it is at least 1.25. Similarly, determine the loan-to-value ratio to evaluate how much capital you need on hand.
  4. Once you have all your documentation, chosen the loan type, and found a suitable lender, provide them with your necessary documents. This includes two to three years of business tax returns, business licenses, bank statements, credit reports, and a detailed plan for the property.
  5. If your application is approved, your lender will provide a loan offer. Don’t hesitate to negotiate terms, such as the interest rate, repayment schedule, and any additional fees. 
  6. Go through the loan agreement and watch out for key clauses such as defeasance and prepayment penalty. Defeasance enables you to substitute the collateral (usually your property) with cash or other assets that generate enough income to meet the mortgage payments. A prepayment penalty is a fee that compensates your lender for the interest payments they'll miss out on if you settle your debt ahead of schedule.
  7. After agreeing on the terms, sign the legal documents and pay any necessary closing costs. Once done, you will receive the funds in your escrow account.

Conclusion

Commercial property loans can be beneficial if you want to purchase investment properties, modernize existing structures, or buy new equipment for your business. 

However, if you’re feeling a little overwhelmed by different loan options and complex clauses, Truss Financial Group is here to offer guidance. We have expert loan officers and advisors who will explain everything and lay out your options so you can move forward confidently. 

For personalized advice or consultation, fill out this contact form, and our team member will reach out to arrange a discussion.

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