Commercial real estate prices are high and may be daunting for small business owners searching for business premises to rent or buy. The lending requirements for commercial real estate loans are strict and the result may be that business owners can’t qualify for the financing they need.
Select Funding provides small businesses financing to companies who need financing and cash on hand to achieve their goals. It’s our passion to make it easy for small business owners to get the money they need even if they can’t qualify for financing with a bank. If you’re looking to buy or rent commercial real estate, we can help. Here are our best pointers to help you get a commercial real estate loan.
What is Commercial Real Estate Lending?
Before we get into the details about how to get a commercial real estate loan, let’s define commercial real estate lending. According to the Federal Deposit Insurance Corporation (FDIC), commercial real estate lending is defined like this:
“Commercial real estate (CRE) lending includes acquisition, development, and construction (ADC) financing and the financing of income-producing real estate. Income-producing real estate includes real estate held for lease to third parties and nonresidential real estate that is occupied by its owner or a related party.”
Commercial real estate lending provides mortgages and other financing to businesses to purchase properties that will be used for business purposes. Some properties that may be considered commercial real estate and paid for with CRE loans include the following:
- Apartment buildings
- Housing developments
- Office buildings
- Retail sales buildings
- Warehouses
- Storage facilities
- Medical facilities
- Restaurants
- Recreational facilities and parks
- Raw land
Any business that requires financing to purchase commercial property will likely need a commercial real estate loan to complete the transaction.
One of the biggest differences between a personal loan and a commercial loan is the amortization period. If you buy a home, the most likely mortgage term is 30 years and the amortization period will also be 30 years. In other words, when you make your final payment, the loan will have been paid in its entirety.
With a commercial loan, the term is often shorter than it would be with an individual loan, ranging from five to 20 years. However, the payments made during the loan term are typically amortized over 30 years. At the end of the loan term, there is a balloon payment due which will pay the remainder of the loan balance.
What Does It Take to Qualify for a Commercial Real Estate Loan?
The qualifications for a commercial real estate loan are based on the risk to the lender as well as on the borrower’s creditworthiness. Given the high failure rate of new businesses, lenders are cautious and the underwriting process is designed to protect them.
The basic requirements for most commercial lenders are as follows:
- Use of Property Being Purchased. The business must occupy 51% or more of the property being purchased.
- Business Structure. Your business must be structured as a business entity and not as a sole proprietorship. (A loan to a sole proprietor would be considered a personal loan, not a commercial loan.)
- Business Credit Score. Your FICO Small Business Scoring Service (SBSS) credit score (ranging from 0 to 300) will need to be at least 155 to qualify for an SBA 7(a) loan. (Note: there are other loan programs where you can get a commercial real estate loan with a lower score.)
- Personal Credit Score. If you are using any personal credit to qualify for the loan, you will need a FICO score of 660 or above.
- Down Payment. In most cases, you will need to make at least a 20% down payment, probably higher. While some personal mortgage programs, such as the FHA and VA loan programs, may allow loan-to-value ratios (LTV) of 90% or higher, most commercial real estate loans have LTVs between 65% and 80%.
- Debt-Service Coverage Ratio. The debt-service coverage ratio, or DSCR, compares a commercial property’s annual net operating income to its annual mortgage debt service and measures the property’s ability to service its debt. To calculate this ratio, you’ll divide the NOI by the debt service. In general, a DSCR of less than 1 indicates a negative cash flow and most lenders prefer a DSCR of 1.25 or higher.
These requirements are the lender’s attempt to protect their interests and ensure that the loan will be repaid.
What is the Interest Rate for a Commercial Real Estate Loan?
The interest rate you pay on a commercial real estate loan will depend upon your creditworthiness, the size of the loan, and the loan program you use. For example, some SBA loans may have lower or higher interest rates than conventional commercial property loans.
Numbers vary but most experts agree that it’s typical to pay between 2% and 11% for a commercial property loan.
The one loan type that tends to have the highest interest rates is a commercial bridge loan. A bridge loan is a form of short-term lending designed to bridge a gap in financing. One example would be the gap between the sale of one property and the purchase of another.
What Types of Commercial Real Estate Loans Are Available?
There are several types of commercial real estate loans to consider if you want to buy commercial property for your business.
Type #1: Ordinary Commercial Real Estate Loan
An ordinary commercial real estate loan is a lot like a residential mortgage loan. The business property being purchased is the collateral for the loan in most cases, but it may also be secured by business equipment or another property owned by the business.
Type #2: Seller-Financed Loans
When a business purchases an income-producing property such as an apartment building, a seller-financed loan may be preferable to an ordinary commercial loan. Seller financing may be more flexible than bank financing and may also come with lower interest rates than would be available from a bank.
Type #3: SBA Loans
The Small Business Administration (SBA) has several loan programs that businesses may want to consider. Since the SBA guarantees part of the loan, there’s less risk to the lender and interest rates may be more favorable than rates for non-SBA loans. (SBA loans may be used to purchase property but are also available for equipment, inventory, debt restructuring, and other business purposes.)
Type #4: Bridge Loans
As we mentioned above, bridge loans are short-term loans that are used to bridge a financing gap. They’re commonly used by property developers who buy land with the intention to build on it and sell it between six months and two years of the loan date. They may also be useful for people who have businesses that buy properties to remodel and resell them, aka property flippers.
Type #5: Hard Money Loans
Hard money loans are also known as private loans, offered by either a private lending company or a private investor. These loans are typically secured by the value of the property being purchased and are most often used when the buyer can’t qualify for a commercial property loan with a bank or credit union. Hard money loans typically have shorter terms than traditional loans, with some being repayable in only a year or two.
Can You Use a Commercial Real Estate Loan for Renovations or to Rent a Property?
What happens if you have a piece of commercial real estate that requires renovation? While our focus so far has been on acquiring a commercial real estate loan to finance the purchase of a property, these loans may also be used to renovate a property that you already own.
Certain SBA loans, including the 7(a) and 504 loan programs, may be used to renovate an existing property. Bridge loans may also be useful for renovations. If you’re buying a property that needs to be renovated, you may be able to borrow more than the purchase price of the property to pay for renovations. The key is that you must have a large enough down payment and good enough credit to qualify for the higher loan amount.
If you need money to rent a commercial space, then a commercial real estate loan is not the answer. However, there are other forms of business financing that can help you get the money you need to pay for your rental.
Tips to Get a Commercial Real Estate Loan
Let’s close with some tips to help you get a commercial real estate loan. We’ve already reviewed the general process, but let’s get into the details:
- Complete your documentation. In most cases, you will need the following documents:
- Your business books and financial records
- Your business tax returns
- Three or more months of business bank statements
- Documents outlining your collateral
- A business plan
- A third-party appraisal of the property
- Improve your credit score. If your business credit score or personal credit score is lower than the minimum thresholds we’ve discussed here, you may want to repay some debt and do what you can to improve your credit scores before you apply.
- Save for a down payment. As we noted above, the LTV for commercial loans is typically 65% to 80%, so you’ll need a minimum down payment of 20% to qualify in most cases.
- Add an investor or cosigner. If your credit is less than ideal, then you may be able to increase your chances of loan approval by adding a real estate investor or getting someone to cosign your loan.
We would also recommend that after you apply for a commercial real estate loan, you respond quickly to any questions from your lender to expedite the underwriting process.
Do You Need Money to Buy Commercial Property?
Buying commercial real estate may be necessary to grow your business. The commercial real estate loan types and information we’ve included here can help you understand what the lending requirements are for a commercial real estate loan, the various types of commercial loans, and what you can do to streamline the underwriting process and increase your chances of approval.
Do you need small business financing to pay for your expenses? Select Funding is here to help. Click here to read about our financing options and begin the application process.
