Last Updated on April 1, 2023
Purchasing commercial property requires a hefty investment. While the price tag is higher, commercial properties generate income that makes the cost worthwhile. Still, most potential buyers will need to finance their purchase. Commercial real estate loans allow you to purchase a commercial property so that you can move forward with your business plans.
What is a Commercial Real Estate Loan?
A commercial real estate loan is precisely what it sounds like: a loan for commercial real estate. Funding from this type of loan is used to purchase income-producing property in the commercial sector.
While these loans are used to purchase real estate, they differ from a traditional mortgage. Here’s how:
- Consumer mortgages are used to purchase homes that will be inhabited. Commercial real estate loans are used to buy retail and multi-family spaces, such as warehouses, offices and apartment complexes.
- Commercial real estate loans typically have shorter terms than conventional consumer mortgages.
- In most cases, commercial loans have longer approval periods, and the application process is more complex.
- Requirements for commercial loans are much more stringent because the risk is so high.
- Lenders may have a lower loan-to-value ratio – typically around 75%-80%.
- When taking out a commercial loan, the property will be collateral. However, some lenders also require borrowers to give a personal guarantee.
Types of Commercial Real Estate Loans
There are several different types of commercial property loans, including:
- SBA (Small Business Administration) loans: The 7(a) and 504 loan programs are available with the SBA, and they allow you to purchase commercial property. These loans are guaranteed through the SBA, but private lenders provide the funding.
- Hard money loans: These are provided by individuals or private companies. Interest rates are generally higher, the repayment term is short (2-5 years usually), and the property will serve as collateral.
- Standard commercial loans: These are the traditional fixed-rate or variable loans that are similar to consumer mortgages.
- Blanket loans: These loans are ideal for purchasing multiple properties. Blanket loans allow you to take out one loan with one set of options and only have to deal with one payment.
- Bridge loans: These short-term loans give you the funds you need to purchase property, sustain cash flow, refinance or improve a property.
If you need to fund a commercial property, having several options means that you can secure a rate and terms that are favorable.
How to Get a Commercial Real Estate Loan
If you’re like most borrowers, you’re probably wondering how to get a commercial loan for real estate. Of course, commercial real estate loan requirements vary from lender to lender, but there are some general requirements that borrowers have to meet. It’s also essential to understand the application and approval process.
Lenders will consider the following when reviewing your application:
Business Finances and Credit
Commercial real estate loans are high-risk. Businesses aren’t guaranteed to succeed, so there is a very real possibility that the borrower may default on the loan. For this reason, commercial property loans are heavily scrutinized.
Lenders will also likely look at your net operating income (NOI), which refers to your debt service coverage ratio. In most cases, lenders will require a ratio of 1.25 or greater.
Additionally, lenders will look at and consider your company’s credit score. The better your score, the lower the rate and the better the terms. For example, to secure an SBA loan, your business must have a FICO Small Business Scoring Service credit score of 155.
There are exceptions, and some lenders are more flexible when it comes to business credit scores.
The commercial property itself will serve as collateral for the loan. If you default on the loan, the lender can seize the property. Most lenders will require the property to be owner-occupied for at least 51% of the structure.
The property’s value must be worthwhile for the lender to approve the loan.
Where to Get a Commercial Real Estate Loan
If you plan on getting a commercial real estate loan, you have several options when it comes to lenders.
Traditional banks are one option. Banks are a great option if your business has excellent credit and you don’t mind going through the extensive application and approval process.
Credit unions, real estate financing firms and alternative lenders are other options for financing.