What are commercial real estate loans?
Commercial real estate loans are mortgages secured by liens on a commercial property, which is a property that is used strictly for business. This might refer to an office building, a shopping center, a hotel, or other income-producing property, but does not refer to an apartment complex or any form of residential property.
A commercial real estate loan is usually made to a business entity rather than an individual. This entity might be a limited partnership, a corporation, a group of developers, a fund or a trust and is generally formed specifically to own commercial real estate. If the entity is young and doesn’t have its own credit history, the owners of the entity may be required to guarantee the loan. This provides the lender with recourse should the loan default.
How do commercial real estate loans work?
Unlike residential loans, which typically range from 15 to 30 years, the terms of commercial loans usually range from five to 20 years. The length of the loan term and the investor’s credit strength will affect interest rates; the longer the term and the weaker the credit strength, the higher the interest rate.
Most banks will also include a balloon repayment in their loans, as commercial loans are not backed by a government entity and can therefore be more risky for lenders. In this scenario, the borrower will pay interest and principal on the mortgage for the first few years and then repay the entire balance in one payment. If the borrower has not saved enough to make the balloon payment, they must either refinance or re-qualify for the loan. If the business has been having issues with money, the borrower may no longer qualify for the loan and risks foreclosure. There are, however, commercial lenders other than banks who may offer long-term loans without balloon payments, although these traditionally carry higher interest rates.
In terms of a down payment, borrowers should expect to be able to put down at least 20 to 25 percent at the start of the process.
What are commercial real estate loan officers looking for?
When applying for a commercial real estate loan, you can expect to provide proof of the following:
1. Credit Scores. Although credit scores are less important for commercial loans than for residential, it’s still ideal for you to have a score above 600. Anything lower will lead to further questioning and, likely, being denied for a commercial real estate loan.
2. Net worth. A general rule of thumb is that your net worth, which is the difference between your assets and your liabilities, should be equal to or greater than the amount you wish to borrow in a commercial real estate loan.
3. Income. A lender will want to see proof of income, whether you work for yourself or receive a W2 each year. If you own other properties, expect to show your global cash flow, or how much cash you earn after paying your debts.
4. Liquidity. Lenders like to see that you have cash left over after making the down payment for a loan. They want to know that you have something left in the event of an emergency. Typically, a lender will want to know that you have 10 to 20 percent of the loan amount left over in liquid cash.
5. Experience. If you will be self-managing the property, the lender will want to be assured that you have previous experience doing so. If you aren’t, the lender will want to see that you have prior experience with owning a large property.
To learn more about how to get a commercial real estate loan or to speak with a professional about how commercial real estate loans could jumpstart your portfolio, please speak with Chris Gardner at CTG Real Estate Services today.