Commercial Real Estate Financing

Commercial real estate loans (CRE loans) are loans that a business can use to purchase or renovate owner-occupied commercial buildings or land.

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As a business owner, one of the most challenging decisions you will face is whether to lease or buy the space in which you operate your business. Owning your commercial space can become a very valuable asset over time, and if managed properly, can ensure your company’s longevity

Understanding the basic details of commercial real estate loans can have a significant impact on your bottom line, and indeed the future security of your business.

Reasons to Purchase Commercial Real Estate

There are two primary reasons that a business owner should consider buying the real estate (building or land) where they operate the business vs. leasing the space. One reason is that owning the real estate will ensure that you can continue to operate your business as long as you hold the property. The second main reason to purchase commercial real estate is for the long-term financial benefit.

Here we will look at the risk factors inherent in leasing vs. buying commercial real estate. You can use the Lease Vs. Buy calculator below to get an understanding of this decision’s comparable costs. Naturally, there are some barriers to overcome in getting a commercial real estate loan, such as down payment and credit qualifications, but understanding the costs associated with each scenario will be a good first step.

Ensuring the future of your business operation

As mentioned above, the primary reason for purchasing commercial real estate is to ensure that you can continue to operate your business in one location for as long as you want. This is especially true for most retail operations, where the old adage of “location, location, location” holds true. Restaurants are a good example of this.

How many times have you heard about a business that’s been thriving for years in the same location – and then suddenly closes its doors? This happens more often than you think. In many cases, this is due to a spike in their lease.

Commercial real estate landlords will look to maximize profits on their properties; that is what they do. So when it’s time to renew a tenant’s commercial lease, the property owner will usually renew it at market rate. It is not uncommon for rental rates on commercial spaces to increase exponentially.

At the end of a lease term, business owners may find themselves priced out of the market and forced to relocate; or, even worse, close their business because the new lease terms exceed their ability to turn a profit.

Naturally, business owners need to be very careful when entering into lease agreements, giving detailed attention to the future of their business operations. Unfortunately, when a company signs their first lease, it is usually at an early stage when the business owner does not have clarity about the future of the business and may be reluctant to sign a long-term agreement.

Leasing your space also comes with the risk that the property owner decides to sell the building where you operate your business, and refuses to extend the lease terms. As a commercial tenant, you give up a lot of control over the future of your location.

Investing in Commercial Real Estate for Your Business

Purchasing commercial real estate will accrue value to your company over time. For more established companies, and for small business owners who are confident of their company’s long-term outlook, making monthly payments toward a commercial real estate loan instead of making payments toward another landlord’s mortgage will allow them to build value in the property and likely earn additional value through property appreciation.

Buying commercial real estate also offers more flexibility in the use of the property. For example, an owner will have the flexibility to subdivide the space when business conditions change, allowing for alternate or additional revenue.

Understanding a Commercial Real Estate Loan

In basic terms, commercial real estate refers to real property that is used for business purposes. In most cases, this is further defined by local zoning laws, which designate real estate for various types of commercial use. Retail shops, office spaces, restaurants, gas stations, hair salons, manufacturing facilities, and warehouses are all examples of commercial real estate.

A commercial real estate loan is designed specifically for acquiring a new or existing commercial property and also for making improvements or additions to those properties.

In most cases, the entity applying for the loan is a legal business entity, like a limited liability corporation oran S-corporation.

How Does a Commercial Real Estate Loan Work?

As with a home mortgage, a commercial property is used as collateral to secure the loan against default, with the lender placing a lien on the property. A lien is the legal right for the lender to seize the commercial property in the event that the borrower doesn’t make their loan repayments.

Lenders will generally require that a commercial loan borrower make a 20% - 30% down payment.Keep in mind that the down payment amount may be negotiable, depending on the lender and the credit profile of the borrower. Below are statistics showing average loan-to-value ratios.

Latest Figures From the American Bankers Association on Loan-to-Value Ratios For Commercial Real Estate Loans

Figure 1-Loan-to-Value Ratios For Originated CRE Loans (source ABA.com)

Types of Commercial Real Estate Loans

  • SBA 7(a) Loan for Commercial Real Estate

    The SBA 7(a) loan program is a loan granted by a bank or other participating financial lender that is guaranteed by the US Small Business Administration. SBA 7(a) loans are the most common loans backed by the SBA. The program helps businesses purchase or refinance owner-occupied commercial properties up to $5,000,000. Interestingly, the majority of the SBA 7(a) loans program is used for working capita.

    Maximum Loan Amount Up to 85 - 90% of purchase price
    (maximum loan amount: $5,000,000)
    Minimum Down Payment 10% - 15%+ of purchase price
    Interest Rates 5% - 8.75%
    SBA Guarantee Fee 0% - 3.75% of guaranteed portion
    Closing Costs 2% - 5% closing costs
    Typical Loan Term 10 - 25 years
    Time to Approval / Funding 60 - 90 days
    Credit Score 680+
    Years in Business 3+ years
    Debt Service Coverage Ratio 1.25+
    Owner-Occupied? 51% +
  • CDC / 504 Loan for Commercial Real Estate

    The SBA 504 loan Program provides approved small businesses with long-term, fixed-rate financing for acquiring fixed assets for expansion or modernization; the loan helps new and existing businesses purchase or refinance owner-occupied commercial property. Like the 7(a), these loans are backed by the U.S. Small Business Administration. They are made available through Certified Development Companies (CDCs), SBA's community based partners.

    Maximum Loan Amount Up to 90% of Purchase Price
    Minimum Down Payment 10%+ of Purchase Price
    Interest Rates 3.5% - 5%
    SBA Guarantee Fee 0% - 3.75% (on SBA amount)
    CDC Processing Fee 0% - 1.5% (on CDC portion)
    Closing Costs 2% - 5% Closing Costs
    Typical Loan Term 20 Years (10 years for equipment purchases)
    Time to Approval / Funding 60 - 90 Days
    Credit Score 680+
    Years in Business 3+ years
    Debt Service Coverage Ratio 1.25+
    Owner-Occupied? At Least 51%
  • Traditional Bank-based Commercial Real Estate Loans

    A traditional commercial real estate loan (or mortgage) is a standard commercial loan issued by a bank or other financial institution (such as an insurance company) that is not backed by the federal government. Traditional commercial real estate loans are used to purchase or refinance such things as an owner-occupied office building, retail center, shopping center, industrial warehouse, and other commercial spaces.

    Some Typical Highlights for Traditional Sources of Commercial Real Estate Loans

    Maximum Loan Amount 65% - 85% Loan-to-Value (LTV)
    Minimum Down Payment 15% - 35% of Purchase Price
    Interest Rates Varies by institution
    Origination Fees 0% - 1% Origination Fees
    Closing Costs 2% - 5% Closing Costs
    Typical Loan Term 5 - 20 Years
    Time to Approval / Funding 30 - 45 Days
    Credit Score 700+
    Years in Business 1-5 Years
    Debt Service Coverage Ratio 1.25+
    Owner-Occupied? At Least 51%
  • Commercial Bridge Loan

    A Commercial Bridge loan or Bridge financing (also known as gap financing, swing financing or hard money loans) is a form of short-term financing designed, as the name implies, to bridge the financial gap between current and future financial circumstances. In the commercial real estate market, a bridge loan is typically used until more permanent financing, such as a mortgage, can be arranged.

    Bridge loans usually have terms of between a few months and a year, although terms can sometimes exceed a year. These are collateralized loans; you typically put up some commercial property you already own or will shortly purchase. The provider of a commercial bridge loan will often approve borrowers based on the value of their collateral rather than on their creditworthiness.

    Some Typical Bridge Loan Averages – Highlights

    Maximum Loan Amount 80% - 90% of Loan-to-Value (LTV)
    Minimum Down Payment 10% - 20% of Loan-to-Value (LTV)
    Interest Rates 6.5% - 9%
    Loan Origination Fees 1% - 6%
    Closing Costs 2% - 5%
    Exit Fee 1%
    Typical Loan Term 6 Months - 36 Months
    Time to Approval / Funding 15 - 45 Days
    Credit Score 650+ Credit Score
    Debt-Service-Coverage-Ratio (DSCR) 1.10+
    Prior Commercial Projects 1 - 3