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What You Need to Know Before Applying for a Commercial Real Estate Loan
Here's a comprehensive guide to applying and qualifying for a commercial real estate loan.
- What Is a Commercial Real Estate Loan?
- Types of Commercial Real Estate Loans to Consider
- Conventional Bank Loans
- SBA Loans
- Bridge Loans
- Hard Money Loans
- Where to Find CRE Loans: Types of Lenders
- Banks
- Private Lenders
- Credit Unions
- Conduit Lenders
- Peer-to-Peer Lenders
- What Lenders Consider Before Underwriting a Commercial Real Estate Loan
- 1. The 5 Cs of Credit
- 2. The Purpose of the Loan
- 3. Your Income and Expenses
- 4. Documents to Prepare for a Commercial Real Estate Loan Application
- Final Thoughts
- Related Questions
- Get Financing
What Is a Commercial Real Estate Loan?
Commercial real estate loans are used for financing the acquisition, construction, repositioning, or refinancing of a commercial property, such as office buildings, retail centers, warehouses, and hotels, as opposed to residential properties. Commercial real estate is usually defined as any income-producing property that is used for business purposes. CRE differs from residential real estate in several key ways, which is why commercial real estate loans are also different.
The most significant difference between CRE and residential loans is the loan amount. Residential loans are typically much smaller because they are meant to finance a single-family home. The average residential loan hovers around $280,000 while the average CRE loan is usually around $2 million. This is because commercial properties tend to be much larger and more expensive than residential properties.
Loan terms also differ for residential and commercial mortgages. While residential mortgages are typically permanent, longer-term fixed-rate loans, commercial loans are often shorter, 5-10 years, can be amortized over a 25-year term, and might come with a large balloon payment at the end of the loan.
Types of Commercial Real Estate Loans to Consider
Conventional Bank Loans
Bank loans are the most common type of financing for commercial real estate properties. They can be used for a variety of purposes, including the acquisition, development, or refinancing of an existing property.
Loan terms usually vary from one lender to another, however, most banks offer competitive rates and don’t require the property to be owner-occupied. Nonetheless, conventional bank loans are typically harder to qualify for due to stricter underwriting requirements. Banks commonly finance mid-to-large-sized projects and require a credit score of at least 660 and a 20% downpayment. Bank loans also carry prepayment penalties, such as yield maintenance, step-down prepayment, or defeasance.
SBA Loans
The Small Business Administration (SBA) offers two main programs that can be used to finance commercial real estate investments: the SBA 7(a) program and the SBA 504 program.
The SBA 7(a) program can be used for a variety of purposes, including the purchase of a commercial real estate property, business, equipment, fixtures, or refinancing debt. The maximum loan amount that can be borrowed through this program is $5 million, however business owners can also opt for smaller amounts that banks are not willing to lend. Down payments are typically 10%.
If you don’t qualify for a conventional loan, the SBA 504 loan program might also be a right fit for you. The loan can be used for financing the expansion or renovation of existing properties, or for refinancing a real estate property. To qualify for an SBA 504 loan, borrowers must again have good credit and be able to put down 10% as a down payment. The maximum loan amount that can be borrowed through this program is $5 million.
One benefit of both SBA 7(a) and 504 loans is that they offer longer repayment terms, which can make them more affordable for borrowers who might not otherwise qualify for a traditional bank loan. SBA loans are also attractive because they often come with relatively low-interest rates. However, borrowers should be aware that these loans do tend to take longer to close than other types of loans — in some cases taking up to 90 days or more from application to funding.
Bridge Loans
Bridge loans are typically short-term loans that are used to finance the purchase of a commercial property prior to securing long-term financing. These loans are usually interest-only loans with terms lasting anywhere from 6 months to 3 years. As bridge loans are meant to be short-term financing solutions, they often come with relatively high-interest rates.
Bridge loans can be helpful for investors in need of quick financing in order to take advantage of a particular opportunity but who might not yet qualify for more traditional forms of financing. For example, let's say an investor finds a great deal on a fixer-upper but needs $200,000 in order to repair and renovate the property before taking out a long-term mortgage or refinancing the property once it has been remodeled. In this case, taking out a bridge loan could make sense because it would provide the investor with the capital they need upfront while allowing them time later on down the road when they may have more equity in the property or may otherwise qualify for more traditional forms of financing.
Hard Money Loans
Hard money loans are another type of short-term financing solution that can be used by investors when traditional forms of financing are not an option — usually due within 1-3 years. Hard money lenders tend to focus more on the value of the property being purchased than on the borrower's credit history or ability to pay back the loan.
SEE ALSO: The Pros and Cons of Hard Money Loans for Commercial Real Estate Investment
As such hard money loans can often be easier to obtain than other types of financing, hard money loans also tend to come with relatively high interest rates and origination fees. Hard money loans should usually only be considered as a last resort when other forms of traditional financing are not possible. But when used correctly, hard money loans can provide investors with much-needed capital in order complete deals quickly which might otherwise fall through.
Where to Find CRE Loans: Types of Lenders
Banks
As mentioned above, banks are conventional or traditional lenders of commercial real estate loans. Banks usually have strict eligibility requirements and mostly finance low-risk projects. Banks also require a large down payment, however, also offer some of the lowest interest rates.
Private Lenders
Private lenders are individuals or companies that lend money to commercial real estate investors. Private lenders are less stringent compared to banks, and the underwriting process usually depends on the purpose of the loan and the type of investment. Private lenders provide more flexible and customized terms, however, interest rates are higher compared to bank loans.
Credit Unions
Credit unions typically have more relaxed eligibility requirements than banks and often offer lower interest rates. However, credit unions usually only finance low-risk projects because they need to generate enough income to cover their operating expenses.
Conduit Lenders
Conduit lenders are large financial institutions that securitize CRE loans into commercial mortgage-backed securities (CMBS). Conduit lenders often offer lower interest rates than banks and other types of lenders because they can spread the risk associated with the loan across multiple investors through the CMBS market.
Peer-to-Peer Lenders
Peer-to-peer lending platforms are online platforms that connect borrowers with individual investors who are willing to fund loans. Peer-to-peer lending platforms typically finance lower-quality projects because they rely on crowdsourcing to raise capital.
What Lenders Consider Before Underwriting a Commercial Real Estate Loan
1. The 5 Cs of Credit
The first thing lenders will consider is your credit history. They will likely look at your credit score and your payment history on other loans or lines of credit. Lenders will also consider your current level of debt, as well as your capacity to take on more debt. In addition, they will take a close look at the collateral you have to offer and your character — whether or not they think you’re likely to repay the loan. This is often referred to as the 5 Cs of credit.
SEE ALSO: Debt Service Coverage Ratio Calculator
2. The Purpose of the Loan
Another important factor that lenders will consider is the purpose of the loan. For example, is the loan for the acquisition of a property? If so, they will want to see evidence that you have a solid plan in place for how you intend to use the property and generate income from it. Lenders will want to see proof that you have the financial resources in place to make a down payment and cover closing costs. In either case, having a well-thought-out business plan is crucial.
3. Your Income and Expenses
Lenders will also want to get an idea of your income and expenses — basically, they’ll want to know if you have enough money coming in to make loan payments on time and in full. To do this, they’ll likely request tax returns and bank statements. They may also ask for documentation of any other assets or liabilities you have. Being able to show that you have a healthy cash flow is crucial when qualifying for a commercial real estate loan.
4. Documents to Prepare for a Commercial Real Estate Loan Application
Business tax returns
Financial reports
Bank statements
Information on collateral
A third-party appraisal of the investment property
Business plan and strategy
What are the qualifications for a commercial real estate loan?
Qualifying for a commercial real estate loan is a more rigorous process than applying for a residential loan. According to SBA7A Loans, you'll need a detailed business plan, the plans you have for the property, 3-5 years of financial documents (business and personal), and your personal credit history.
What documents are required to apply for a commercial real estate loan?
To apply for a commercial real estate loan, you will need to provide the lender with personal details, a resume, the last three or more years' income tax returns (personal and business), a business plan (which should include a balance sheet, cash flow statement, and projected income statement), a rent roll (for an apartment building or self-storage unit business), a schedule of leases (for retail or office space), information on any upgrades to an existing building, and a third-party appraisal of the investment property. Additionally, the lender may want to see a business plan and strategy.
For more information, please see the following sources:
What are the different types of commercial real estate loans?
There are three main categories of commercial loans: bridge loans, permanent loans, and SBA loans. Bridge loans are short-term loans that are used to finance a property until a more permanent form of financing can be obtained. Permanent loans are long-term loans that are used to finance the purchase of a property. SBA loans are government-backed loans that are used to finance the purchase of a property. Additionally, there are many other types of commercial property loans, such as construction loans, mezzanine loans, and hard money loans. Each has unique upsides and downsides, and every investor should weigh all options available to make the best financing decision for their strategy.
For more information, please see the following sources:
What are the advantages and disadvantages of a commercial real estate loan?
The advantages and disadvantages of a commercial real estate loan depend on the type of loan you are taking out. For example, an SBA 7(a) loan has advantages such as being easier to qualify for than other types of loans, being able to be used for a variety of purposes, and having terms of up to 25 years for real estate. Disadvantages include potentially difficult qualification if you don't have a strong credit history, significant paperwork required by the SBA, and not being able to be used for investment properties.
CMBS loans also have their own advantages and disadvantages. Advantages include providing a reliable source of low interest rate financing to borrowers who otherwise might not qualify. Disadvantages include tough prepayment penalties.
For more information, please see the following sources:
What are the risks associated with a commercial real estate loan?
The risks associated with a commercial real estate loan include an increase in monthly payments at the end of the interest-only period, and the possibility of owing more than the property is worth if the property's value decreases. Additionally, borrowers should be aware of the loan-to-value ratio (LTV), type of business, credit score, and overall financial health and stability, which will affect the interest rate. Upfront fees such as a 20-30% down payment, property appraisal, survey fees, legal costs, and loan origination may also be required. It is important to speak with a qualified commercial real estate broker to discuss all of the risks and benefits associated with this type of financing.
What are the best practices for applying for a commercial real estate loan?
The best practices for applying for a commercial real estate loan include:
- Researching different loan products and lenders to find the best fit for your needs.
- Gathering all the necessary documents and information to provide to lenders.
- Using a Commercial Mortgage Calculator to get a better picture of your CRE financing scenario.
- Preparing to provide detailed information about your business, including financial statements and tax returns.
Our team at Commercial Real Estate Loans can help you find the best financing option for your deal — fill out the form to connect with us, and an advisor will get in touch with you.
- What Is a Commercial Real Estate Loan?
- Types of Commercial Real Estate Loans to Consider
- Conventional Bank Loans
- SBA Loans
- Bridge Loans
- Hard Money Loans
- Where to Find CRE Loans: Types of Lenders
- Banks
- Private Lenders
- Credit Unions
- Conduit Lenders
- Peer-to-Peer Lenders
- What Lenders Consider Before Underwriting a Commercial Real Estate Loan
- 1. The 5 Cs of Credit
- 2. The Purpose of the Loan
- 3. Your Income and Expenses
- 4. Documents to Prepare for a Commercial Real Estate Loan Application
- Final Thoughts
- Related Questions
- Get Financing
Final Thoughts
Applying for a commercial real estate loan can be intimidating, and there are no shortcuts to it, therefore it is important to fully understand the process and have the right tools to obtain a loan. Our team at Commercial Real Estate Loans can help you find the best financing option for your deal — fill out the form below to connect with us, and an advisor will get in touch with you. Until then, check out our Commercial Mortgage Calculator to get a better picture of your CRE financing scenario.