Because you need money to make money
Collateral is king when lenders look for ways to reduce risk. Nowhere is that more true than commercial real estate financing, which puts your business property under a lien while you pay back the loan. Less risk can mean lower interest rates, longer loan terms, and higher loan amounts, making this a solid choice for a particular type of business owner. Is that you? Let's find out.
Commercial Real Estate Financing, or a CRE Loan, is a type of mortgage where the loan is secured by your commercial property. CRE is a piece of investment property used solely for business, and it can take its form in retail, offices, industrial warehouses, and apartment complexes.
One of the first things to consider when diving into the world of CRE financing is what type of business you intend to grow. Unlike a residential loan, CRE properties are intended only for business purposes.
CRE properties include office buildings, retail chains, warehouses, apartment complexes, and special-purpose locations like car washes, storage units, or churches. Of course, the most popular properties to choose from are office and retail, although every single property will bring its unique advantages.
There are a few main steps to getting a commercial real estate finance loan. The first involves deciding upon whether you will file your property as an individual or an entity.
With most CRE loans, a property will be filed as an entity, and the loan will be made to corporations, funds or trusts, and limited partnerships. An entity will usually not have a financial track record, which means a lender could require the entity's owners to bestow a guarantee. A guarantee is a promise to pay any debt the investor may have.
Although filing as an entity is the most common, there is also a choice to file as an individual business owner. Something to keep in mind when filing as an individual investor is that your lender will want assurance that all loans can be repaid. The lender will ask for financial track records to be provided to secure the loan.
If starting a new business with no previous credit history, a lender will ask the investor to make a guarantee, or promise, that the loan will be paid back.
Next, evaluate your options and decide which CRE loan option will best benefit the company. It's important to note that CRE loans are not backed by Freddie Mac and Fannie Mae, two essential government agencies. This means higher interest rates could be charged. A commercial real estate loan will also have a set term that could range anywhere from five to twenty years, depending on your financial history.
The final steps include calculating your loan-to-value ratio (LTV) and debt service coverage ratio (DSCR). The LTV will measure and compare the values of your loan to your property. The DSCR will determine the company’s available cash that can be used to pay debt.
An LTV will usually range anywhere from 65% to 80% for a commercial loan. However, it is good to note that a lower LTV can qualify for a more favorable financial rate. This is because a lower LTV will have more stake in a property, which means less risk from the lender's point of view.
It is also important to know that for DSCRs, a lender will usually look for at least 1.25%. Anything that is less than one percent shows lenders there is negative cash flow.
Before a provider decides whether or not to approve you for a secured loan for an investment property, they will often look at your proposed collateral and determine its worth. In these situations, the more valuable the collateral, the better chance you'll be approved for a mortgage loan and the less interest you might end up paying. With CRE financing, you offer your CRE as collateral for your funding. Providers like this type of collateral because the property is generally a safe investment. The interest rate for this type of funding can be comparatively low.
Financing for CRE is not the same thing as getting funding to pay for CRE. With this type of funding, you use real estate you already own as collateral to get money to pay for specific business projects, such as the construction of a structure on your commercial property. This type of funding is risky because if you default on the agreement, you could lose the property that your business is built on.
If you need the money fast, you might be disappointed about how long it can take to get approved for commercial real estate financing or other types of business loans. Remember, the provider will need to look at your business's finances and the value of the real estate you will use as collateral. This takes time.
The best places to find more information about pursuing a commercial real estate loan are with banks and commercial lenders. Banks will be able to provide CRE financing for many different types of properties. They will also be able to guide you one-on-one throughout the process of gaining that commercial real estate loan. Commercial lenders are financial businesses that are best suited for providing commercial real estate loans to smaller companies. An advantage to commercial lenders is that they offer fast approval and lower prices.
You may even want to look at a loan program online.
While each lender has its own set of requirements for a commercial real estate loan, many consider the following factors:
The minimum down payment for a commercial real estate loan will vary depending on the lender. However, it is typically between 15% and 35% of the total purchase price.
Typically, commercial real estate lenders don’t allow early repayments. As such, you likely won’t be able to make early payments without incurring a prepayment penalty.
Non-recourse commercial loans are secured by collateral. In the event of default, the lender can only repossess the assets that were put up as collateral to secure the loan. The borrower’s personal assets cannot be seized.
Each lender will set its own credit score requirement for a commercial real estate loan. In most cases, a minimum credit score of 660 is required.
