Commercial real estate is expensive; few can buy it in cash and generally rely on loans. You must know that a commercial real estate loan differs from a residential loan and that certain rules and criteria must be considered before applying.
Trusts, developers, and individuals can borrow from commercial banks, credit unions, and private equity lenders to purchase or construct commercial real estate. For a commercial real estate loan, you must qualify and meet security, income, and credit requirements.
Whether you need a commercial real estate loan for an owner–occupied mortgage, income-producing mortgage, or construction loan, you must consider all the requirements and criteria. The qualifying process is different from that of a home mortgage, and here are some of the differences and factors to help you with your CRE loan.
How Does A Commercial Real Estate Loan Work
Commercial real estate loans (CRE loans) allow an investor, business, or individual to finance properties like office buildings, shopping malls, apartment complexes, or warehouses. These loans are used to acquire a new property, renovate, or refinance debt on a commercially owned property.
Business entities like corporations, trusts, or developers and, in some instances, individuals apply for CRE loans, and most lenders require that a larger part of the business be owner-occupied. Generally, the business applying for the loan occupies 51% or more of the real estate.
Personal and commercial real estate loans are similar but with a few differences. One of the key differences is that a commercial loan is secured by a “Lien” placed against the property. Lenders require some form of security (collateral) against the loan, and the legal claim (Lien) protects the lender if the loan goes unpaid. Once the commercial loan is paid in full, the Lien is removed.
Not all CRE loans are the same, and their structure and approval depend on many factors, including:
- The type of loan
- The lender
- The property
- If the property is already financed
- Financial profile
Commercial Real Estate Loan Rates And Costs
Commercial real estate loans are different compared to your normal residential loan. Generally, a CRE loan’s 30-year prime mortgage rate is between 0.5% and 1% higher than residential loans. The type of loan, property, financial profile, and various other factors affect the rate, which currently ranges between three and twenty percent.
A commercial real estate loan repayment term is shorter than a residential mortgage, making it more expensive. CRE loans have a closing cost that ranges between 3% and 5% of the borrowed amount. In the case of an SBA loan and depending on the amount borrowed, a 3.75% security fee must be paid.
Types Of Loans For Commercial Real Estate
Commercial real estate loans take on various forms, which depend on several factors. A loan structure will depend on whether it is funded by a private equity lender, a commercial bank or credit union (senior lender), or the public debt market like a commercial mortgage-backed security.
Finding your way around all the CRE loan intricacies is difficult, but here are the three general categories:
Owner–Occupied Commercial Mortgages
An owner-occupied commercial mortgage is when the property standing as collateral for the loan is occupied and owned by the operating company. Such loans depend on the business’s financial health since the company operating within the property repays the mortgage.
Owner–occupied commercial loans rely on how long a business will remain profitable and usually amortize over 20 to 25 years. A debt service coverage (DSC) ratio calculates the building and the company’s operating expenses holistically to avoid calculating dule occupancy costs.
Income-Producing Commercial Mortgages
Loans for income-producing commercial properties rely on third parties like tenants to cover the property’s expenses, which include repaying the mortgage loan. These loans are popular among investors, and there are various factors, like the quality of the tenants and the lease maturity profile, considered before a loan is approved.
Income-producing commercial loans are subject to property class and other factors but usually amortize over 15 to 25 years. Generic offices and versatile properties often get a longer repayment structure than higher-risk specialized properties like golf courses and self-storage units.
Construction Loans
Qualifying for a construction loan is difficult due to the high-risk factors where the property’s cash flow potential is determined in advance. These specialized commercial loans fund the new development and redevelopment of buildings without an existing monthly payment support structure.
The full amount of the construction loan stands as credit for the building, and as the construction progresses and reaches a predetermined milestone, a set amount is released. Money released during the stages, sometimes called “progress draws,” continues until the project is complete. Once the project is complete, the principal amount, including the accumulated interest, is paid in full.
Generally, the property sale proceeds, an income-producing mortgage, or an owner-occupied mortgage will repay the construction loan. Any of the three repayment options mentioned above are accepted, but the choice depends on whether the property will be leased by tenants or owner-occupied.
Requirements For Commercial Real Estate Loans
Various factors influence CRE loans, and the qualifying process differs from a home loan. These loans are repaid with business revenue, which makes them a high risk for lenders. Securing a commercial real estate loan has various requirements and falls into three main categories.
Security – The property must secure CRE loans and generally require a 25% to 30% equity stake in the property borrowed against. The lender requires a 25% or larger down payment to qualify if you are buying. Lenders require adequate property insurance and will check the deed for any outstanding claims or Liens against the property.
Income – Like all loans, CRE loans require proof of income to confirm that your expenses do not exceed your income, hindering monthly loan payments. A DSCR metric is one of the common methods for lenders to qualify your income, which includes three basic requirements:
- Two years of personal and business tax returns.
- Business operating agreement and organization documents.
- Personal records, including your W-9, passport, and birth certificate.
Credit – Before you apply for a CRE loan, you must build a good business credit. Although lenders differ in credit requirements, most look for at least two years of business experience to provide a proper baseline.
The lender will check your company credit score as part of the qualification procedure. In some situations, as part of a personal guarantee, they will also ask for your personal credit score. Minimum credit scores typically range between 660 and 680, but some lenders accept slightly lower credit scores.
Conclusion
Commercial real estate loans are for business properties, and lenders have strict approval requirements. To qualify for a CRE loan, lenders generally consider the business and personal criteria of the borrower, which include good credit, security, and proof of income. The viability and success of the commercial real estate and the borrower are crucial to qualify for a CRE loan.