Borrowing for commercial real estate is different from a home loan

 

Commercial real estate (CRE) is income-producing property used solely for business (rather than residential) purposes. Examples include retail malls, shopping centers, office buildings and complexes, and hotels. Financing—including the acquisition, development, and construction of these properties—is typically accomplished through commercial real estate loans: mortgages secured by liens on the commercial property.

 

Just as with home mortgages, banks and independent lenders are actively involved in making loans on commercial real estate. Also, insurance companies, pension funds, private investors, and other sources, including the U.S. Small Business Administration’s 504 Loan program, provide capital for commercial real estate.

 

Here, we take a look at commercial real estate loans, how they differ from residential loans, their characteristics, and what lenders look for.

 

Residential Loans vs. Commercial Real Estate Loans

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Commercial Real Estate Loans:

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• Commercial real estate loans are usually made to business entities (corporations, developers, limited partnerships, funds, and trusts).

• Commercial loans typically range from five years or less to 20 years, with the amortization period often longer than the term of the loan.

• Commercial loan loan-to-value ratios generally fall into the 65% to 80% range.

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Residential Loans:

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• Residential mortgages are typically made to individual borrowers.

• Residential mortgages are amortized loans in which the debt is repaid in regular installments over a period of time. The most popular residential mortgage product is the 30-year fixed-rate mortgage.

• High loan-to-value ratios—even up to 100%—are allowed for certain residential mortgages, such as USDA or VA loans.

 

CRE loans exist to finance property that’s used for business-related purposes, such as shopping malls, warehouses, apartment complexes and office buildings. A CRE loan can be used to buy new property, renovate existing income-producing property or refinance debt on a commercial property you already own.

 

Often, CRE loans are made to a business entity such as a corporation, developer or trust, though an individual can borrow one as well. Most of these loans require that the property is owner-occupied, meaning your business resides in at least 51% of the building.

 

 

Unlike residential loans, the terms of commercial loans typically range from five years (or less) to 20 years, and the amortization period is often longer than the term of the loan.

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A lender, for example, might make a commercial loan for a term of seven years with an amortization period of 30 years. In this situation, the investor would make payments for seven years of an amount based on the loan being paid off over 30 years, followed by one final "balloon" payment of the entire remaining balance on the loan.

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For example, an investor with a $1 million commercial loan at 7% would make monthly payments of $6,653.02 for seven years, followed by a final balloon payment of $918,127.64 that would pay off the loan in full.

The length of the loan term and the amortization period affect the rate the lender charges. Depending on the investor’s credit strength, these terms may be negotiable. In general, the longer the loan repayment schedule, the higher the interest rate.

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Loan-to-Value Ratios

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Another way that commercial and residential loans differ is in the loan-to-value ratio (LTV), a figure that measures the value of a loan against the value of the property. A lender calculates LTV by dividing the amount of the loan by the lesser of the property’s appraised value or its purchase price. For example, the LTV for a $90,000 loan on a $100,000 property would be 90% ($90,000 ÷ $100,000 = 0.9, or 90%).

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For both commercial and residential loans, borrowers with lower LTVs will qualify for more favorable financing rates than those with higher LTVs. The reason: They have more equity (or stake) in the property, which equals less risk in the eyes of the lender.

High LTVs are allowed for certain residential mortgages: Up to 100% LTV is allowed for VA and USDA loans; up to 96.5% for FHA loans (loans that are insured by the Federal Housing Administration); and up to 95% for conventional loans (those guaranteed by Fannie Mae or Freddie Mac).

Commercial loan LTVs, in contrast, generally fall into the 65% to 85% range. While some loans may be made at higher LTVs, they are less common. The specific LTV often depends on the loan category. For example, a maximum LTV of 65% may be allowed for raw land, while an LTV of up to 85% might be acceptable for a multifamily construction.

There are no VA or FHA programs in commercial lending, and no private mortgage insurance. Therefore, lenders have no insurance to cover borrower default and must rely on the real property pledged as security.

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Debt-Service Coverage Ratio

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Commercial lenders also look at the debt-service coverage ratio (DSCR), which compares a property’s annual net operating income (NOI) to its annual mortgage debt service (including principal and interest), measuring the property’s ability to service its debt. It is calculated by dividing the NOI by the annual debt service.

For example, a property with $140,000 in NOI and $100,000 in annual mortgage debt service would have a DSCR of 1.4 ($140,000 ÷ $100,000 = 1.4). The ratio helps lenders determine the maximum loan size based on the cash flow generated by the property.

A DSCR of less than 1 indicates a negative cash flow.6 For example, a DSCR of .92 means that there is only enough NOI to cover 92% of annual debt service. In general, commercial lenders look for DSCRs of at least 1.25 to ensure adequate cash flow.

A lower DSCR may be acceptable for loans with shorter amortization periods and/or properties with stable cash flows. Higher ratios may be required for properties with volatile cash flows—for example, hotels, which lack the long-term (and therefore, more predictable) tenant leases common to other types of commercial real estate.

Office of the Comptroller of the Currency. 

 

Interest Rates and Fees

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Interest rates on commercial loans are generally higher than on residential loans. Also, commercial real estate loans usually involve fees that add to the overall cost of the loan, including appraisal, legal, loan application, loan origination, and/or survey fees.

Some costs must be paid upfront before the loan is approved (or rejected), while others apply annually. For example, a loan may have a one-time loan origination fee of 1%, due at the time of closing, and an annual fee of one-quarter of one percent (0.25%) until the loan is fully paid. A $1 million loan, for example, might require a 1% loan origination fee equal to $10,000 to be paid upfront, with a 0.25% fee of $2,500 paid annually (in addition to interest).

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Prepayment

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A commercial real estate loan may have restrictions on prepayment, designed to preserve the lender’s anticipated yield on a loan. If the investors settle the debt before the loan’s maturity date, they will likely have to pay prepayment penalties. There are four primary types of “exit” penalties for paying off a loan early:

• Prepayment Penalty. This is the most basic prepayment penalty, calculated by multiplying the current outstanding balance by a specified prepayment penalty.

• Interest Guarantee. The lender is entitled to a specified amount of interest, even if the loan is paid off early. For example, a loan may have a 10% interest rate guaranteed for 60 months, with a 5% exit fee after that.

• Lockout. The borrower cannot pay off the loan before a specified period, such as a five-year lockout.

• Defeasance. A substitution of collateral. Instead of paying cash to the lender, the borrower exchanges new collateral (usually U.S. Treasury securities) for the original loan collateral. This can reduce fees, but high penalties can be attached to this method of paying off a loan.

Prepayment terms are identified in the loan documents and can be negotiated along with other loan terms in commercial real estate loans.

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What Credit Score Do You Need for a Commercial Real Estate Loan?

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It is generally recommended that you need a credit score of 620 or higher for a commercial real estate loan. If your score is lower, you may not be approved for one, or the interest rate on your loan will be higher than average.

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How Many Years Is a Commercial Loan?

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The term of a commercial loan can vary depending on the loan but is generally lower than a residential loan. Commercial loans can be anywhere from five years or less to 20 years. There are also mini-perm loans for commercial properties that can run for three to five years.

 

A commercial loan may be extended to a business to help with their short-term funding needs. These loans typically require the business to post collateral, which may be in the form of property, equipment, or inventory that the bank can seize from them should they default on the loan or go into bankruptcy.

 

 Many commercial loans require collateral, such as property or equipment. Companies generally have to provide financial statements to prove their ability to repay.

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TERMS

 

Eligible Properties:

 

Conventional, mixed-income , affordable and subsidized Developments

 

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​Qualified Borrower:

 

For-profit or non-profit single asset, single purpose entity.

 

 

Loan Amount:

 

Minimum $1,000,000; no maximum.

 

Interest Rate:

 

Variable or fixed rate options available.

 

 

Security:

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First lien position on real estate.

 

Term:

 

Up to 36 months.

 

Guarantee:

 

Guarantees required from creditworthy and experienced guarantor(s).

 

 Prepayment:

 

 Allowable at Any time.

 

 

Closing:

 

Dependent upon timely submission of required due diligence items; typically, 90 to 120 days. Lender will strive to meet required deadlines as requested.

 

 

Draw Funding:

 

 Construction draws processed once per month upon receipt of all required documentation.

 

 

 

Third Party Reports: 

 

Appraisal, Market Study, Phase I, and Plan & Cost Review reports are required

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​SIMPLY REQUEST A COMMERCIAL LOAN 

APPLICATION TO GET STARTED

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