How to Qualify a Commercial Real Estate Loan
Author: Woodsboro Bank
Purchasing commercial property can help a business grow, whether it needs to set up a new facility or expand existing operations. However, it requires a major financial commitment, and many businesses turn to commercial real estate loans to finance such purchases.
When applying for a commercial real estate loan, the lending institution will want to ensure that your company is able to cover repayments on the loan. There are three main categories that are used by banks when determining who qualifies for a commercial real estate loan: security, income, and credit. Here is a closer look at each one.
Lenders need to determine whether a loan is properly secured by the property a company is borrowing against before approving a loan. The commercial property is normally used as collateral for the loan, and lenders will be able to seize it should the borrower fall behind on their mortgage repayments. This means the property has to carry sufficient value for the lender to recover their losses in the event of a foreclosure.
Therefore, most businesses are required to have at least 25 to 30% equity in the property before they can obtain this type of loan. This means that it will be necessary to make a down payment of at least 25%.
Lenders will also check that adequate property insurance has been obtained to protect against any damage to the property that serves as collateral on the loan. They will also verify the property’s title and deed to make sure there are no claims or outstanding liens against it.
Moreover, many lenders require that the property be owner occupied, which means the business must occupy at least 51% of the building. However, the rest of the property can be rented out for additional income if desired.
A major consideration in qualifying for a commercial real estate loan is the business’s income. When a lender processes a commercial real estate loan application, they look for companies to have a considerable amount of income compared to their expenses as this assures them the business will be able to make its monthly payments.
Lenders often use a metric known as the debt-service coverage ratio, or DSCR, when deciding whether a business qualifies. Most lenders are looking for a DSCR of at least 1.25, although the specific minimum varies depending on the type of property the company is borrowing against.
Lenders typically request the last two years of tax returns for the business. They will also ask for personal tax returns as the company’s owner will be asked to sign a personal guarantee. You will need to supply personal documentation such as a copy of your birth certificate or passport, W-9 forms, and the business’s operating agreement and other organization documents.
For properties that serve as commercial rentals, the lender will also take into account the rental income that the borrower receives when calculating the company's cash flow. In some cases, borrowers may be asked to assign their interest in leases and rents from the building over to the lender with the stipulation that the lender will only take these profits and rents in situations where the borrower defaults on the mortgage.
Credit checks form an important part of the commercial real estate loan qualification process. Lenders will assess the business's credit score, as well as the personal credit of the individual providing a personal guarantee on the loan, which is typically the owner. For most conventional loans, the minimal credit score many lenders look for is somewhere between 660 and 680.
However, credit score alone is not enough for lenders to determine whether you qualify. They will also want to know how long a company has been in business. Most lenders prefer businesses that have been operating for at least a year or two as this allows them to better assess the company's revenue.
Another factor many lenders consider is how experienced the owner is in terms of running the business. They may also request proof of assets or savings that could be converted into cash to demonstrate that the borrower can pay the mortgage for a certain amount of time, such as six months, should they experience a major business loss.
Businesses should be structured as business entities, such as S corporations or limited liability companies, to qualify for commercial real estate loans. A loan that is issued to a sole proprietorship is considered a personal loan rather than a commercial one and can put your personal wealth at stake if you default on it.
Contact the Commercial Lending Professionals at Woodsboro Bank
If you are considering purchasing a commercial property, the experienced professionals at Woodsboro Bank can help you find the right lending solution. Contact us today to schedule an appointment to discuss your options.
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