Commercial Real Estate Financing

Commercial Real Estate Financing

A commercial real estate loan in Texas, as opposed to a residential real estate loan, is a mortgage secured by a lien on business property in cities inside Texas. Commercial real estate (CRE) is any income-producing real estate utilized for commercial purposes, such as office buildings, shops, hotels, medical offices, and apartment complexes.

Small businesses that want to buy, expand, or refurbish their locations may apply for a CRE loan. Corporations, developers, partnerships, funds, trusts, and real estate investment trusts, or REITs, are the most common recipients of CRE loans in the real estate market.

To put it another way, commercial real estate entities are founded specifically for the aim of owning and operating commercial real estate. The company entity buys commercial property, leases out space, and then collects rent from the tenants. Commercial real estate loans are used to fund the enterprise, which includes the acquisition, development, and construction of these properties.

Commercial banks, credit unions, independent private lenders, pension funds, insurance companies, private real estate investors, and other capital sources, such as the US Small Business Administration’s 504 Loan Program, are all engaged in providing CRE loans, just as they are with residential property. Commercial lenders, like residential lenders, take varying amounts of risk and have varying terms to give to borrowers.

Types of Commercial Real Estate (CRE) Loans

Here are the most common types of CRE loans and their loan features:

Permanent Loans are first mortgages on a commercial property. A permanent loan must have some amortization and a term of at least five years written into the contract.

Commercial Mortgage Loans are loans that include financing. The financing is secured by any business property or investment property. This type of commercial loan requires a personal guarantee. Commercial mortgage loans are provided by the Federal Deposit Insurance Corporation FDIC-backed entities. These FDIC entities include banks and credit unions.

Commercial mortgage loans have loan terms that can range from one year up to 30-year loans with commercial mortgage rates starting from 4% to 12%.

Conduit Loans or commercial mortgage-backed security (CMBS) loans are combined with other mortgages and placed into a Real Estate Mortgage Investment Conduit (REMIC). REMIC is an entity that issues mortgage-backed securities and also generates income for issuers and investors who bought the combined mortgages. 

Conduit loans are used for real estate properties that include retail buildings, shopping malls, warehouses, offices, and hotels. They have fixed interest rates and balloon payments at the end of the loan term. Loan terms are from five years up to 30-year loans.

SBA Loans are written by traditional and non-traditional lenders but are guaranteed by the SBA.

There are several different SBA loans that cater to different types of borrowers, the most popular being the 7(a) loan. The SBA 7(a) loan funds the full business loan. The full business loan can finance several expenses like purchase, refinance, renovation, or ground-up construction of commercial real estate. In addition, the funds from the SBA 7(a) loan can also be used by business owners for expenses, such as working capital, equipment, inventory, partnership buyouts, debt consolidation, business purchases, leasehold improvements, and expansions.

Another SBA loan is the SBA 504 loan. The SBA 504 loan is another government-guaranteed small business loan. This government-guaranteed small business loan is funded by 50% of the participating commercial mortgage lender, 40% by a Certified Development Company (CDC), and 10% by the borrower as cash or equity. The SBA 504 funds can only be used by business owners to purchase machinery, business land, and new facilities, as well as to modernize existing facilities and streets and utilities. 

Bridge Loans provide a short-term first commercial mortgage loan on a commercial property, typically with a six-month to a three-year term. Bridge loans are typically obtained when a borrower is waiting for longer-term financing or attempting to refinance an existing obligation.

Commercial Real Estate Loan Interest Rates and Fees

Commercial real estate loan interest rates and fees are typically more expensive than residential loans in the commercial mortgage market. Typical down payments range from 20% to 30% of the total buying price. Commercial loan rates are also generally higher than residential loans, ranging from 10% to 20% for most borrowers. As of January 2019, loans backed by the Small Business Administration (SBA) (see below) are among the most affordable in the market, with commercial mortgage rates ranging from 7.75 percent to 10.25 percent, depending on the size and length of the loan.

Commercial mortgage lenders tie their commercial loans to an index. An index, such as the prime rate and LIBOR, measures the rate of change in market securities. Commercial mortgage rates are determined by the U.S. Treasury Bonds. The U.S. Treasury Bonds establish the upper limits for real estate loan charges. The commercial mortgage rates are impacted by the 10-year Treasury bonds. The 10-year U.S. Treasury bonds serve as the points of reference for how much can commercial and residential lenders can charge and also plays a significant part in the commercial mortgage market.

Repayment Schedules for Commercial Loans

Monthly payment: This is the loan amount you’ll pay each month in a set amount. It consists of the principal, interest, and fees.

Total payments: This is the total of all loan payments due, which includes the principal amount borrowed plus interest and fees.

Total interest paid: The total interest paid is the amount charged by the commercial mortgage lender for the loan. You may be able to save money on interest if you repay the loan early.

APR: This figure shows the loan’s true yearly cost, making it easier to compare goods on an apples-to-apples basis. Some private lenders do not provide an annual percentage rate (APR) and instead provide a generic interest rate that does not include any costs. The annual percentage rate (APR) for real estate financing is determined by your credit score as well as the financials of your company, including annual revenue and time in operation.

Commercial Real Estate Loan Calculator

A commercial real estate loan calculator computes the monthly payments and total interest costs of a small-business loan. To use a calculator, you will need to have the following information:

  • Loan amount.
  • Loan term.
  • Estimated annual percentage rate.

Commercial Real Estate Loan calculators also use your credit score, to provide your business financing choices.

Commercial Real Estate Loan Requirements

What do lenders look for?

Lenders and loan officers look for three requirements before granting commercial loan approval to your small business. These requirements for a commercial mortgage application are most likely related to the finances of your company, your personal finances, your business plan, your company profile, and the qualities of the property.

Business Finances

Commercial real estate loans are typically scrutinized closely since small enterprises are seen as risky, and many fail. Banks and commercial lenders will examine your books during the loan application process to ensure that your company has enough cash flow to repay the loan.

Your company’s debt service coverage ratio, which is defined as your annual net operating income (NOI) divided by your annual total debt service (the amount you’ll have to pay back principal and interest on your loan), is likely to be calculated by a lender. A usual requirement is a ratio of 1.25 or higher. If your company is debt-free and you apply for a $100,000 commercial real estate loan, the lender will expect you to earn a net operating income of at least $125,000.

Business Credit

Business Credit is where the lender and loan officer will also look at your company’s credit score to determine your eligibility for a commercial mortgage loan and the terms that would apply (interest rate, payback time, and down payment requirement). The SBA 7(a) loan, the government agency’s flagship loan program, requires a minimum FICO Small Business Scoring Service (SBSS) credit score of 155, while there are lots of exceptions that allow small firms to acquire a loan with a credit score lower than that.

A business entity, such as a limited liability company or an S corporation, should be formed for your small firm. If you default on a real estate loan to a sole proprietorship, it will be regarded as personal rather than commercial, putting your personal fortune in danger.

Personal Finances

Small businesses are typically run by an owner or a few partners. Banks, credit unions, and other commercial lenders will look at your personal credit score and history to discover if you’ve had any previous financial issues, such as defaults, foreclosures, tax liens, court judgments, and so on. A bad personal credit rating can hurt your business’s chances of getting commercial loan approval.

Property Characteristics

The collateral for this type of loan is the property being financed, and the lender adds a lien to the property that authorizes seizure if you don’t repay on time. Your small firm will typically need to occupy at least 51 percent of the building to qualify for a commercial real estate loan. Otherwise, you should apply for an investment property loan, which is designed specifically for rental houses.

Hard-money Loans

Hard money loans are loans that private direct lenders often provide based only on the value of the property, with little regard for the borrower’s creditworthiness. Commercial buildings, storefronts, and facilities such as a warehouse or labs are all eligible for hard money loans. Single-family homes won’t qualify for this type of loan, but a multi-family property can if you use a hard money loan for your business and it takes up at least 51 percent of the space.

A loan-to-value ratio (LTV) of 65 percent to 80 percent is typical for commercial real estate loans, like construction loans. For example, if the property is valued at $200,000 and the commercial lender demands a 70% LTV, you’ll be required to put down $60,000 in order to secure a $140,000 hard money loan.