What Is A Commercial Real Estate Loan?

Author: Woodsboro Bank

Categories: Blog

commercial real estate loansA commercial real estate loan is a type of mortgage designed for the purchase of commercial properties. A property can be considered commercial if it is intended for profit generation purposes, such as an office or retail space that is used for operating a business. In addition to purchasing property, a company may obtain a commercial real estate loan if they intend to renovate or expand their business. These types of loans function differently from other types of small business loans and are more similar to residential mortgages. They can be used for commercial properties such as office buildings, apartment buildings, restaurants, hotels, shopping centers, and industrial buildings. Many commercial real estate loans will require the business to physically reside in more than half of the building.

Types of Commercial Real Estate Loans

There are many different types of commercial real estate loans available, and the terms and rates vary by lender and depend on the type of property that is being financed. They may come with variable or fixed interest rates. The down payments can range anywhere from 10% to 30%, with repayment terms typically falling within a range of five to 25 years. Some are fully amortized, while others use interest-only payments and a final balloon payment when the term ends. Here is a look at some of the financing options available for purchasing commercial real estate.

Conventional Bank Loans

A commercial real estate loan from a bank is secured by the property that it is being used to purchase or renovate, much in the same way that a residential mortgage functions. Some banks may offer fully amortized loans that have terms of up to 20 years and a loan-to-value ratio of up to 80%. Other lenders might only offer interest-only loans using 10-year terms and loan-to-value ratios of 65%. It tends to be more difficult to qualify for traditional commercial real estate loans from a bank compared to other types of commercial real estate loans. Banks look for business owners who have a good personal credit score. They also consider their debt service coverage ratio (DSCR). They prefer a high ratio, which indicates that the business is bringing in enough revenue to comfortably repay the loan. Calculating DSCR involves dividing annual net operating income by yearly debt payments; most lenders want to see a score of at least 1.25. Although there may be strict approval requirements, these types of loans typically have lower interest rates than some of the other options.

SBA 7(a) Loan

The US Small Business Administration (SBA) offers a 7(a) loan that can be used to buy buildings or land, renovate an existing property, or construct a new one, as long as it is owner occupied. Borrowers are entitled to receive as much as $5 million from an SBA-affiliated lender. The rates for these loans are based on the lowest prime rate, the SBA optional peg rate, or the 30-day LIBOR rate. These types of loans are fully amortized and use repayment terms of up to 25 years.

SBA 504 Loan

The SBA also offers a specialized type of loan for owner-occupied real estate known as 504 loans. These can also be used for long-term equipment purchases. This type of loan is a combination of two different types of loans. A certified development company offers up to 40% of the loan amount, while 50% comes from a third-party lender. The borrower’s obligation is a 10% down payment.

Commercial Bridge Loan

A bridge loan is a way for borrowers to obtain financing quickly to bridge the gap until they are able to go through the longer process of securing long-term financing for commercial property. It may be useful in cases where a business owner needs to compete with all-cash bidders on a specific property; they can then refinance the loan to a long-term one once they have obtained the property.

Bridge loans typically have short terms between six months and three years and have to be paid in full once they have matured. These tend to have notably higher interest rates than the going market rate.

Commercial bridge loans are typically provided by alternative lenders, but banks and credit unions occasionally extend this type of financing as well. However, qualifying can be very challenging and requires a very low debt-to-income ratio and strong credit.

The right commercial real estate loan depends on how quickly the business needs the funds, its ability to qualify for different options, and its long-term goals.

Reach Out to the Community Commercial Banking Professionals

Woodsboro Bank offers customized lending options that suit the needs of local businesses. Contact us today to schedule an appointment with one of our experienced commercial lending professionals to discuss your objectives.