What Is a Commercial Loan for Rental Income?

A commercial loan for rental income is a type of financing used to purchase or renovate income-generating properties. For example, a real estate investor may use one to purchase a multifamily apartment building or commercial property to lease to tenants.

These differ from conventional mortgages that are typically reserved for owner-occupied single-family homes. Instead, commercial loans are designed for investment properties that generate rental income. These loans can help investors expand their real estate portfolio or start building one.

Types of Commercial Loans for Rental Income

If you’re looking for commercial loans for rental income, you have multiple options to consider. Each funding type is unique and has different pros and cons worth evaluating. Understanding each type can help you decide which loan makes sense for your business goals.

1. DSCR Loans

Debt service coverage ratio (DSCR) loans are an appealing financing option, as lenders typically evaluate the property’s cash flow and income potential rather than a borrower’s personal income.

When it comes to commercial loans for rental income, DSCR loans can be useful because they may expand accessibility for borrowers. Instead of qualifying based on strict income requirements, lenders place more of an emphasis on the debt service coverage ratio.

The debt service coverage ratio (DSCR) is calculated by taking the net operating income (NOI) and dividing it by the total debt service.

Though every lender has different requirements, a DSCR of at least 1.25 may be necessary to qualify for financing. In this case, a higher DSCR can illustrate that a property generates sufficient income to cover loan payments comfortably. A lower DSCR can be considered a risk.

For self-employed borrowers and real estate investors, DSCR loans can be a solid funding solution to purchase an investment property. Lenders look at the property's value, cash flow, and income generation to determine if you qualify.

Just be aware that lenders may still consider your credit score and history, cash reserves, occupancy, and the condition of the property as well.

2. Commercial Real Estate Loans

Commercial real estate loans provide financing for investors to purchase, refinance, or renovate income-producing commercial properties. These loans are typically used to finance non-owner-occupied properties that generate rental income. For example, multifamily apartment buildings, office buildings, warehouses leased to tenants, or retail centers.

Lenders generally evaluate the value of the property as well as the borrower’s financial profile as part of the underwriting process.

Borrowers may need to provide tax returns, bank statements, financial statements, and more to qualify. Additionally, lenders may consider the net operating income (NOI), loan-to-value (LTV), and debt service coverage ratio (DSCR) to assess eligibility and the property’s income potential.

3. Portfolio Loans

Portfolio loans can help real estate investors secure financing for multiple properties. For real estate investors with complex situations, portfolio loans can be appealing as they tend to have more flexible underwriting criteria.

Lenders manage portfolio loans rather than outsourcing them to others. This gives lenders more control and enables them to work with borrowers based on their unique circumstances.

For investors with a dozen rental properties, qualifying for traditional financing may be difficult. Portfolio loans can be a valuable alternative, as lenders may work with borrowers with nontraditional income and finances.

4. Commercial Bridge Loans

Commercial bridge loans are a type of short-term financing that can cover any gaps until you get permanent financing. These loans tend to have shorter repayment terms of six months to three years and typically have higher interest rates.

If you have a time-sensitive fix-and-flip or need to renovate a rental property right away, commercial bridge loans can help.

Why DSCR Loans Can Be a Good Financing Option for Real Estate Investors

Debt service coverage ratio loans, or DSCR loans, can be a good financing option for real estate investors looking to grow their portfolio.

DSCR loans are unique as qualification is typically based on a cash flow analysis of your rental property income. Instead of scrutinizing your annual income and employment, lenders look at the potential income generated by the property. For smaller-scale self-employed investors, this can be attractive.

These loans have different qualification requirements, which can enhance approval odds and may require less documentation than conventional loans. DSCR loans can help real estate investors qualify for financing to secure additional properties.

How to Compare Commercial Loans for Rental Income

Commercial loans for rental income can vary depending on the type as well as the lender. As a borrower, it’s best to thoroughly research options and evaluate many different factors. Below, we cover what to consider before taking out a loan to buy a commercial property.

1. Interest Rates

Compare interest rates on different commercial loans for rental income to understand what’s typical in the market.

Some might have fixed rates that are static and remain the same throughout repayment. Other options might have variable rates that can swing in either direction depending on economic and other contributing factors.

In general, factors that may contribute to interest rates include:

• Credit score
• Loan size
• Loan-to-value (LTV) ratio
• Collateral
• Occupancy status
• Type of property
• Debt service coverage ratio
• Market conditions

2. Repayment Terms

Check out the repayment terms and obligations on various commercial loans for rental income. Some things to look at include the term, amortization period, balloon payments, and whether the loan has interest-only options or comes with prepayment penalties.

3. Loan-to-value (LTV)

Lenders have different loan-to-value ratio requirements. Your loan-to-value refers to how much you borrow relative to the property’s value. A lower LTV can indicate less risk for a lender, whereas a higher LTV may be considered more of a risk.

4. Down Payment

In general, getting a commercial loan for rental income requires a higher down payment than a traditional residential mortgage. Down payments can depend on the type of loan, lender, property type, debt service coverage ratio, creditworthiness, occupancy status, and level of experience.

5. Fees

When you compare commercial loans for rental income, consider all the potential fees that can contribute to higher costs. These can include:

• Origination fees
• Closing costs
• Property appraisal fees
• Underwriting or administrative fees
• Prepayment penalties

How to Choose the Right Commercial Loan for Rental Income

When choosing a commercial loan for rental income, it’s essential to choose an option that aligns with your goals as a real estate investor. Consider the following:

• Investment strategy: Consider your overall investment strategy and whether this is a buy and hold opportunity or a fix-and-flip. Understand if this will support long-term cash flow and how the funds will add value.

• Property type: The type of property you plan on purchasing can impact which type of commercial loan is the best fit.

• Financial goals: Evaluate your financial goals. Are you looking for the lowest monthly payment, fast closing, maximum leverage, or flexible qualification?

• Experience level: First-time investors, experienced investors, and portfolio owners may have different needs and qualify for different types of loans.

• Long-term plans: Review your business plan and evaluate your long-term plans. Whether you purchase one property or plan on multiple acquisitions, that can impact which financing option is the best fit.

Final Thoughts

Commercial loans for rental income can come in various forms and help real estate investors and businesses get the financing they need. DSCR loans in particular have become an appealing option as they use different underwriting criteria and primarily focus on income-generating potential over personal income.

When searching for funding options, it’s key to compare the loan structure, repayment term, fees, along with interest rates.  Researching several lenders and types of loans can provide important information and help guide your decision.