Any real estate that is used exclusively for business purposes is considered commercial real estate. Business owners may purchase commercial real estate either as a place to conduct or expand their own company, or as an investment used to generate capital.
Small business owners who are just starting out, or those who see rapid growth in their company, may decide that expansion to a new location or a significant overhaul of their present real estate space is on order.
But even entrepreneurs possessed with worlds of savvy in their own chosen business field might need some guidelines when it comes to navigating the sometimes tricky and confusing labyrinth of options of commercial real estate loans.
A business owner might decide to purchase either a new commercial property or an existing piece of commercial real estate. A commercial real estate loan is a mortgage loan that is secured by a lien on the real estate that is being purchased, not on residential property. A lien is a legal right granted by the owner of property, by a law or otherwise acquired by a creditor. A lien serves to guarantee an underlying obligation, such as the repayment of a loan.
Before delving into the different types of commercial real estate loans that a business owner might consider, let’s look at the different categories of commercial real estate.
Commercial real estate can be broken down into six basic categories, with some fairly wide variations within the subdivisions of each of those categories.
1) Office Buildings
Office buildings are generally classified in three types: Class A, Class B and Class C facilities.
Class A office property is first-class, high-end, expensive real estate that is located in the most desirable areas for commerce–such as downtown in the midst of a large city. Class A office buildings are characterized by cutting-edge architecture, premium access and professional management. Financial institutions, law firms and nationally known companies are likely to house their businesses within Class A office buildings, whether they are impressive high-rises or large, sprawling edifices on pristinely landscaped, self-contained campuses.
Class B office property is a cut below, lacking the supreme amenities found in a Class A office building. Nonetheless, Class B office space is generally functional and more than sufficient for most businesses. Class B buildings are usually older than Class A facilities, with more moderate rents. Class B buildings usually stand four stories tall or less, and rather than being located in the heart of a large business district, are often located in suburban areas or on the outskirts of larger financial districts.
Class C office property is, comparatively, “bare bones.” Located in lower-traffic, less desirable areas, Class C office space doesn’t boast the kind of attractive amenities or the attractive appointments of Class A or even Class B office facilities. They command lower rents and are usually occupied by small businesses with less money to spend on office space. Some might liken a Class C office building to the residential equivalent of a “fixer-upper,” an aging facility in evident need of repairs or upgrades. With those upgrades, a Class C property could, in some cases, be eligible to qualify as a Class B property, but never a Class A.
2) Industrial Buildings
Usually located outside of city centers, and often residing along major highways, industrial buildings are almost always of the low-rise variety, even though within that definition, they take on several different forms and purposes.
Heavy manufacturing buildings contain large machinery that manufacturers use to build or create products and goods.
Light assembly buildings serve the purposes of both manufacturing and storage, and because the products assembled within are usually not as heavy or cumbersome as those built in heavy manufacturing factories, these types of buildings are not as customized.
Bulk warehouses occupy massive amounts of space. Most bulk warehouses are used to store goods. Buildings of this type generally are located near roads to facilitate distribution of the goods to where they are needed.
Flex Warehouses serve multiple purposes. They can be used for light assembly, but they also have office space, and are capable of being partitioned, so that both manufacturing and office work can be done.
Sales to the general public take place inside retail establishments, which — in an age when so much commerce now takes place online — are commonly referred to as brick-and-mortar stores. Some retail centers are single-use and others are multi-tenant.
Strip centers — small shopping centers also referred to as “strip malls” — consist of disparate retail businesses that share a structure and a parking lot. Pizza parlors, convenience stores, pharmacies, nail salons, ice cream parlors and dry cleaners are some of the types of stores located in a strip center. Larger strip centers might have an anchor tenant, which is a larger retailer–often a nationally known one–whose presence attracts shoppers to the center and, in theory, helps enhance the business of the other retailers in the center.
Community retail centers occupy a space of 150,000 to 350,000 square feet. Most of these buildings have multiple anchor tenants.
Regional malls are like super-sized strip centers in spaces that can range from 400,000 square feet to more than 2 million square feet. Unlike strip centers which might be located near a small town center, regional malls require vast parking lots or decks and contain multiple anchor stores.
Out parcels are located near retail businesses, but their land is as of yet not developed. Out parcels are intended to be used for future construction of a retail business or a bank. Out parcels are vacant lots that also are called “pad sites.”
Any type of real estate intended for residents, other than single-family structures, with multiple separate housing units within one building or several buildings within one complex are considered multifamily real estate.
Multifamily properties are more expensive than some other forms of commercial real estate, but with multiple rents coming from multiple tenants, financing these properties isn’t as difficult.
Some multifamily types include:
- Garden Apartments: These are usually three or four stories high with between 50 and 400 units, no elevators and surface parking (not deck parking).
- Mid-rise Apartments: Consisting of between five and nine stories, with between 30-110 units, and elevator service, mid-rise apartments are more common in urban areas, but also may be located in the suburbs.
- High-rise Apartments: Located in larger markets, high-rise apartments are professionally managed and contain upwards of 100 units–sometimes many more than that.
- Walk-ups: These structures have between four and six stories, but no elevators.
- Manufactured housing communities: The manager of these communities leases ground sites to owners of manufactured homes.
- Special-purpose housing: These are multifamily properties with more specific purposes, where it is to house students, senior citizens or low-income residents.
Establishments that include accommodations for travelers and tourists fall under the banner of hotels and hospitality, although within this sector, there are full-service hotels, limited-service hotels and extended-stay hotels.
Other types of lodging are boutique hotels and resorts.
A plot of undeveloped land also can be considered commercial real estate if that is what the buyer intends to use the property for (and the land is in an area that is zoned for commercial use).
There are three types of land that a commercial real estate buyer can purchase: Greenfield land, infill land and brownfield land. Greenfield land has never been used, so there is no need to demolish or rebuild any existing structures. Infill land is vacant land in the midst of a developed area, such as an empty lot between homes in an existing newer subdivision, or an available piece of land between older homes or buildings. Brownfield land was previously developed, but is not currently occupied or in use. Parcels classified as “brownfield” often are environmentally contaminated from the prior presence of industry on the site.
There also are a number of special purpose categories of commercial real estate that don’t neatly fit into any of the aforementioned six classifications. Self-storage facilities, churches, amusement parks, bowling alleys, car washes, theaters, marinas, nursing homes and community centers all can be defined as commercial real estate.
Commercial lending can enable a business to expand via the acquisition of additional commercial property. There are six types of commercial real estate loans: SBA 7(a) loans, CDC/SBA 504 loans, traditional commercial real estate mortgages, commercial bridge loans, hard money loans and conduit/CMBS loans.
The profile of an applicant for a commercial real estate loan is a business owner who has a good credit history (680 personal credit score or better), annual revenue of at least $250,000 and a company that has been in business for several years.
What are the best commercial real estate loans for you?
This explanation of each type of commercial real estate financing might help clarify the situation for the small business owner considering taking on a commercial mortgage.
1) SBA (7a) Loans
The U.S. Small Business Administration (SBA) offers commercial financing backed by the SBA through its SBA 7(a) loan program. The most common type of SBA loans, SBA 7(a) loans assist businesses in the purchase or refinance of owner-occupied commercial properties up to $5 million. They also give the business owner a chance to borrow funds for working capital.
These loans are suited to assist businesses that are unable to secure credit anywhere else. With an SBA (7a) loan, the borrower can buy land or buildings, build on new property or renovate existing property as long as the real estate will be occupied by the owner. Through an SBA (7a) loan, an entrepreneur can borrow up to $5 million through an SBA-affiliated lender. The maximum allowed interest rates for the program are based on the Wall Street Journal Prime Rate plus a margin of a few percentage points. Interest rates can be fixed, variable or a combination of the two. Loan terms for 7(a) loans that are used for commercial real estate may be as long as 25 years for repayment. Each monthly payment would be the same until the loan is fully repaid.
2) CDC/SBA 504 Loans
Backed by the U.S. Small Business Administration, this type of financing can assist in the purchase or refinance of an owner-occupied commercial property. These 504 loans are actually a hybrid form of financing: One loan coming from a Certified Development Company (CDC) for up to 40 percent of the loan amount, and one loan from a bank for half the loan amount or greater. Low down payment requirements make CDC/SBA 504 loans ideal for growing companies that might not have more than 10 percent to use as a down payment.
A CDC/504 loan is for either 10 years or 20 years. Borrowers get a fixed rate rather than the prime lending rate. Applicants will be required to show the lender a business plan, exhibit proof that they’re capable of managing a business and present projected cash flow data–all to assure the lender that the loan is likely to be repaid without complications.
3) Traditional Commercial Mortgages
Standard commercial financing through a bank, a traditional commercial mortgage is not backed by the federal government. Borrowers use these mortgages to buy commercial properties–or to refinance them–that fall under one of the six categories discussed above: office buildings, industrial buildings, retail property, multifamily structures, hotels or land.
Traditional commercial mortgages usually have loan interest rates between 5 percent and 7 percent, with closing costs ranging from 2 percent to 5 percent. Repayment terms could be as short as five years or as long as 20 years, with full amortization over the life of the loan.
Qualifying for a traditional mortgage is not as easy as other types of commercial real estate loans. A strong personal credit history, a reliable business and a low debt service coverage ratio are things that lenders look for.
4) Commercial Bridge Loans
A short-term form of funding, a commercial bridge loan can close a gap that exists between the capital a business owner requires right now and a longer-term answer to financing. A bridge loan for a business can help a company owner get his or hands on cash in an expedient manner when there is a present shortfall in cash while expenses remain particularly pressing.
A small business might consider a bridge loan to keep the company solvent and able to pay its bills during a time when cash on hand is scarce but invoices that are outstanding are on their way to being paid off. If a business is in the market for new real estate, but lacks the time required to go through the process of securing a mortgage, the company owner might opt to seek a bridge loan.
A bridge loan intended to cover expansion plans answers the need for capital, so that a growing company can hire more employees, search for more spacious accommodations or renovate and expand present space, and buy the time needed to expand.
5) Hard Money Loans
Commercial real estate financing can also be expedited through a hard money loan from either a company or an individual. These loans can be achieved faster than securing credit from a bank, which requires more regulation clearances. The time frame difference between a hard money loan and a traditional loan from a bank could be the difference between a week or two and a month or two.
Hard money loans are comparable to bridge loans, with one big difference: the down payment and interest rate on a hard money loan usually will be higher than a bridge loan, because of the higher risk of default. But it’s a possible solution to the need for fast capital.
6) Conduit/Commercial Mortgage Backed Security (CMBS) Loans
Structured as a permanent, fixed-rate commercial real estate loan, a conduit loan (also referred to as a Commercial Mortgage Backed Security loan) is a type of commercial mortgage that is packaged into a pool with commercial loans that are similar and securitized and sold in the secondary market to institutional investors. The loans in the pool are held in trust and are considered the collateral for the mortgage backed security.
CMBS loans provide lower fixed-rates than traditional commercial real estate loans. Prepayment on a conduit loan is in the form of defeasance, which allows the borrower to buy substitute collateral for the conduit loan. Most conduit loans have terms of five to 10 years with 20- to 30-year amortization periods.
Any business owner who occupies more than 51 percent of the commercial property may apply for any of these types of financing. If it all seems cumbersome or confusing even after reading this guide over, it is advisable to consult with a broker who understands all the ins and outs of commercial real estate loans.