Are you a small business owner or commercial property investor who is interested in purchasing a new business location, adding one or more properties to your portfolio, or maybe renovating an existing space?

commercial real estate (CRE) loan could help make your dream a reality.

At its simplest, a CRE loan is a type of mortgage. Instead of being secured by a residential property, a lien is placed on a commercial property or a claim is made on business or rental revenue. The commercial property could be almost any real estate that produces income for business purposes. This includes things like offices, retail establishments, hotels, restaurants, and apartment buildings.

CRE loans are generally made to small business owners or investors who own and operate commercial real estate. They’re offered by banks, independent lenders, insurance companies, online lenders, pension funds, private investors and other financing organizations, such as the U.S. Small Business Administration (SBA). Loan decisions are based on many factors, including the quality and condition of the property involved in the transaction, the creditworthiness of the borrower (not their net worth), and the viability of the companies operating in the property. CRE financing usually comes with higher interest rates or payout terms than residential mortgages.

CRE loans are typically used by small businesses that want to purchase, expand, or renovate their sites. They’re also made to investors like corporations, developers, funds, trusts, partnerships, and real estate investment trusts, which are more commonly referred to as REITs. These investors are business entities created for the purpose of owning and operating commercial real estate locations. The entities buy commercial properties for the specific reason of renting them out to the businesses that operate within them. The financing for these real estate ventures, which can be used for doing things like acquiring, developing, constructing, and improving business locations is done through commercial real estate loans.

How commercial real estate loans work

Much like residential property mortgages, CRE loans can be funded through banks, lending institutions, insurance companies, pension funds, private investors and other sources of capital. The loans can be guaranteed by the U.S. Small Business Administration, even if they’re provided directly through other lending institutions. Different lenders are willing to take on different levels of risk, and the terms of the loan will depend on the risks associated with it and current market and economic conditions. For example, a credit union will be less likely to take on significant risk when compared with larger, more established traditional banks.

CRE loan terms are typically shorter than residential ones. The most popular home loan is a thirty-year fixed rate mortgage. Commercial property loan terms typically range from five years to twenty, although they can be shorter in certain circumstances. When selecting a commercial property loan option, it’s important to select one with the right repayment term to avoid unnecessary prepayment penalties.

An interesting twist on CRE loans is that the amortization period is sometimes longer than the loan term. For example, the term of a CRE loan could be seven years with a thirty-year amortization. That means the loan monthly payments are calculated based on a 30-year repayment term, which lowers them. However, it makes it necessary to close out the loan with a very large balloon payment that covers the remainder of what’s owed on it.

When people apply for CRE loans, in order to determine eligibility, lenders consider the nature and quality of the property involved, the creditworthiness of the purchaser (which is usually determined by reviewing three to five years of financial statements and tax returns), the borrower’s personal credit score and credit history, the business credit score and annual revenue along with standard financial calculations such as the loan to value ratio and the debt service coverage ratio. A lender may also want to review the business plan of the borrower or tenant.

The down payments required are relatively high when compared with residential real estate loans. They typically range from 20 to 30 percent of the purchase price. Interest rates are also comparatively high, ranging from ten to twenty percent for most borrowers, depending on their creditworthiness. Loans that are backed by the Small Business Administration generally come with lower rates, usually below ten percent. SBA-backed rates are dependent on the size and term of the loan.

Want to learn more about using a commercial real estate loan to finance a business property? Biz2Credit’s “how to” guide explains everything you need to know.

Types of commercial real estate (CRE) loans

CRE loan uses can be broken out into three categories 

  1.     Loans for investment
  2.     Loans for development
  3.     Loans for businesses.

The most common types of CRE loans for these uses are:

Conventional commercial mortgage loans

Conventional commercial loans are similar to a mortgage you’d get if you were purchasing a home, but they’re used for business purposes and come with shorter terms. Many commercial real estate investors purchase business property using these traditional, fixed-rate mortgages.

Lenders typically require at least a 25 percent upfront down payment as a qualifying requirement for a fixed-rate mortgage with terms of between five and 30 years (most fall within the five- and ten-year range.)

In order to qualify, lenders will order a professional appraisal to confirm that the property valuation is accurate. They’ll also request and review financial documents that prove the rents that can be collected on the property will cover the debt service.

Conventional commercial mortgage loans are generally used by investors who are buying an existing, already occupied building that is generating positive cash flow. Borrowers must have good credit ratings to qualify for these relatively low interest loans. They’re typically available through larger traditional banks and financial institutions.

Commercial bridge loans

A commercial bridge loan typically provides short-term capital that’s used to service debt while the owner of the property improves it, seeks refinancing or waits to complete a property-related transaction. They’re often leveraged by property investors that have a large balloon payment coming due and are awaiting refinancing into a more traditional commercial loan. Or they’re used by property owners to pay for repairs that could result in higher rents and revenue.

The term of these loans is usually between six months and a year, and because of their limited terms, come with relatively high interest rates.

Commercial bridge loans are available from lenders that specialize in working with businesses. 

Commercial hard money loans 

Hard money loans are an alternative source of capital offered outside of traditional lenders, either from individuals or companies. These are often referred to as “loans of last resort”. 

These loans are used by people who need to act quickly to purchase, refinance or renovate a business property. They have low underwriting standards and come with short terms. Loan decisions are based more on the value of the property than on the borrower’s credit score.

Hard money loans are not regulated and can be used for virtually any purpose. The loan application process is comparatively simple. They’re often leveraged in risky situations or when other financing isn’t possible. They also come with the highest interest rates. People who are considering hard money loans, even those with bad credit, should think twice about whether they have other options available to them.

Small Business Administration (SBA) 7(a) loans

This is one of two SBA loans that can be used for commercial real estate purposes. The other is SBA 504 loans, which will be covered in the next section. Both are backed (or guaranteed) by the United States Small Business Administration, a federal government agency dedicated to providing support to small businesses.

SBA 7(a) loans are the most common type of Small Business Administration loan. SBA 7(a) loans are most commonly used for working capital, but they can also be leveraged to buy commercial real estate.

They’re able to be used to help businesses buy or refinance commercial properties more than 51 percent occupied (based on square footage) by the owner’s operation. The real estate can be worth up to $5 million. 

At least a ten percent down payment is required to qualify for an SBA 7(a) loan. The business owner must have a good credit score and the business must have been in operation for at least three years, which means this isn’t a good option for startup companies but could be ideal for established businesses. Loan terms are typically ten to 25 years and interest rates fall between five and nine percent. The loans are offered through SBA-approved lenders.

The SBA answers frequently asked questions (FAQs) about 7(a) loans on the SBA.gov website.

Small Business Administration (SBA) 504 loans

SBA 504 loan program is similar to the SBA 7(a) one. The key difference is that they don’t come with a maximum loan amount. These loans can be used to cover up to 90 percent of the purchase price of a business property, regardless of its cost.

SBA 504 loans typically come with 20-year terms when they’re used to buy commercial real estate. (The term is typically ten years for other types of business needs.) They come with interest rates of between three and five percent. Similar to SBA 7(a) loans, the business of the owner must occupy at least 51 percent of the square footage of the property. These loans can be secured from SBA-approved lenders.

Interesting fact: Many smaller businesses think microloans, business lines of credit, or business credit cards could be possible options for financing a company property. These options either don’t have the scale — or come with the right terms or protections — to fund business property purchases or improvements.

Commercial mezzanine loans

Mezzanine loans are a unique type of small business loan that can be structured as either debt or equity. For example, it would be junior debt if it’s used as a second mortgage on a commercial property. It can also be secured as preferred equity, convertible debt, or participating debt.

Here’s more information about each of these:

Junior debt

This is a secondary source of capital, which means it’s repaid only after a more senior loan is repaid in full. This kind of debt can be leveraged for acquiring property or developing it.

Preferred equity

This is an equity investment in a business property-owning organization. It provides a fixed, preferred return that’s paid back before those investments made by common equity interests. This type of equity is often used in joint ventures.

Convertible debt

This is a form of debt — or borrowing — that can be transferred into common equity with defined terms.

Participating debt 

This is a way to borrow where the investors receive interest payments and a percentage of the revenue generated by a business property. This can include rental income and sales proceeds. This type of debt is usually used to finance commercial properties housing top tier tenants with long-term leases.

No matter the type, mezzanine financing is subordinate to senior debt, such as a traditional mortgage. Mezzanine financing is unique because it’s not secured by the property, but by the owner of it, which makes it a riskier form of debt. Because of this, the cost of mezzanine capital is higher than a real estate loan.

Want to know whether you can get a business loan for commercial real estate? Our insightful blog article can help you find out.

The bottom line on commercial real estate financing

There are many types of loans and financing options available to small business owners and commercial real estate investors. It’s important to work with someone who understands the pros and cons of each. Biz2Credit’s experts are always available to provide sound advice and counsel on the best loans and business financing options for you, including the ones with the lowest closing costs.

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