Is commercial real estate (CRE) part of your business’s growth plan?

If so, it’s important to understand CRE loans. In this article, we’ll cover what CRE loans are, how they differ from home loans, and the five main types you’ll find.

What Are CRE Loans?

Traditional lenders (i.e., bricks-and-mortar banks and credit unions) are the most common source of CRE loans.

The types of commercial real estate are numerous, from storefronts to factories and offices to hotels. CRE loans exist to enable businesses to buy, build, renovate, or refinance income-producing properties. In many cases, these loans come with an owner-occupancy requirement, meaning that the borrower must use at least 51% of the property’s leasable space for the purpose of running their business.

With a few exceptions, CRE loans are self-secured, meaning they’re collateralized by the same asset they’re financing. In this respect, they’re like traditional residential mortgages. However, because of the inherent risks of doing business (and the rarity of commercial mortgage insurance, which is typically used only for exceptionally large projects), commercial loans are more expensive. CRE loans typically come with higher interest rates and shorter loan terms, which raises monthly payments.

Traditional lenders (i.e., brick-and-mortar banks and credit unions) are the most common source of CRE loans. Certain loan products are also available from specialized lenders, private investors, and nonprofit economic development organizations.

What’s the Difference?

If you’re a homeowner, you’re familiar with how home loans work. CRE loans differ in several key areas:

Residential Loans

• Loans are made to an individual or individuals.
• Rates and fees are slightly lower, on average.
• Mortgage insurance is generally required for down payments less than 20%.
• Loan terms typically range from 15 to 30 years.
• Loan-to-value (LTV) ratio can be up to 100% for some mortgage products.
• Credit requirements are based on personal credit scores and reports.
• Income requirements are based on paystubs and tax returns.
• There’s usually no penalty for prepayment.

CRE Loans

• Loans are typically made to business entities (e.g., corporations, LLCs, or trusts).
• Interest rates and fees are slightly higher, on average.
• Mortgage insurance is rarely available or required.
• Loan terms are typically in the five- to 20-year range and often have a longer amortization period.
• LTV ratios are usually in the range of 75%.
• Credit requirements are based on business and/or personal credit, depending on the business’ credit history.
• Income requirements are based on the debt-service coverage ratio (DSCR): (net operating income)/(total debt service), though lenders will ask for supporting financial documentation, as well.

5 Types of CRE loans

From permanent mortgages to short-term capital solutions, CRE loans come in many forms:

1. Conventional Loans
   Widely available from banks and credit unions, these are most like residential mortgages. They can have a fixed or floating rate and sometimes end with a one-time balloon payment. They’re frequently used by businesses that have good credit and want to purchase an existing property with positive cash flow.

2. Small Business Administration (SBA) Loans
   SBA 7(a) loans are also written by traditional lenders, but they’re guaranteed by the federal government. They can be used by qualified small businesses to finance owner-occupied real estate up to $5 million, with as little as 10% down. SBA 504 loans can be used for real estate projects, while 7(a) loans can be used for other things, too, like buying equipment, machinery, supplies, and more.

3. Hard Money Loans
   This form of short-term financing is usually provided by specialized lenders. Like conventional and SBA loans, they’re secured by the property, but they have lower underwriting standards, laxer regulations, faster turnaround times, and higher interest rates. Hence, they’re often considered a last-resort option for entrepreneurs who need to move fast.

4. Bridge Loans
   Also known as caveat loans or swing loans, these are another short-term financing option for business operators who need to access capital while a property is being renovated, leased, sold, or refinanced. They commonly come with terms of six months to three years and higher interest rates than conventional loans.

5. Mezzanine Loans
   No, these aren’t for building an extra floor in your building – they’re a hybrid of debt and equity financing that are sometimes used to fill the gap between a primary mortgage and the amount of cash that the business owner can raise. They often come with high rates and fees, and lenders have the right to convert the debt to an equity interest in the company in the event you default.

Preparing for Success

If you’re looking to obtain a CRE loan with the best possible terms, you’ll need to learn how lenders make their decisions. Study up on the key factors that determine CRE creditworthiness and take action to optimize your position as a potential borrower.

Ready to Move Forward?

An experienced commercial real estate lender can help you explore all your options and pick the loan product that best fits your capacities and goals. Get in touch today.

 

 

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