The Basics of Commercial Real Estate Financing and How To Select the Best Option for You

– By Ashok Kumar, CFO, Creative Choice Group

Commercial real estate loans vary significantly from residential real estate loans. For one, whereas residential real estate loans are made out to the individual, commercial mortgages go to business owners. If you hope to finance commercial real estate, you would need to form a business entity before a real estate finance company would even consider you.

Additionally, commercial mortgages require collateral. Though commercial properties have huge potential to yield sizeable returns, they also pose a significant risk to lenders. To minimize this risk, lenders put a lien on the property. Should you default on your payments, the bank can then seize the property and resell it.

Another way in which commercial financing differs from residential financing is the fact that many lenders require no money down. Financing methods such as investing partners, purchase money mortgage, or hard money lenders make it possible for investors to jump right into commercial property ownership without putting forth significant capital.

Real Estate Finance Options for Commercial Properties
Now that you understand how commercial financing differs from residential financing, it’s time to familiarize yourself with the various lending options. By educating yourself on the numerous methods, you can decide on the best that is right for your budget and current circumstances. It is important to note real quick that you don’t have to use commercial property loans strictly for purchasing real property. You can also use the financing to pay for a construction project or to maintain a property so that it remains fully functional and ready for leasing.

Bearing that in mind, it’s time to explore the options available to you. The following are available to you through private lenders, financial institutions, pension funds, insurance companies, and even the U.S. Small Business Administration:

1) Conventional Bank Loan: Conventional bank loans for commercial property work similarly to those for residential properties. Banks and traditional lending institutions will want to see that a borrower has a decent credit score of at least 660 and has at least a 20% down payment. If you can meet these requirements, you may find that going through a bank is your best option, as conventional bank loans typically offer competitive interest rates.

2) Joint Venture Loan: Joint venture options are ideal for investors who either cannot obtain financing through other means or who don’t want to shoulder the risk of such a significant investment on their own. Two or more individuals can apply via a single loan application, and all involved parties will share the risks and returns equally.

3) SBA 7A Loan: 7A loans through the Small Business Administration are some of the least expensive and most attractive types of loans for commercial property. The SBA guarantees repayment of the portion of a loan, which reduces some of the risks for borrowers. The 7A loan works best for small projects, and though interest rates are higher for this than an SBA 504 loan, it continues to remain the SBA’s most popular commercial real estate finance option.

4) SBA 504 Loan: If your investment project is valued at over $1 million, consider the SBA 504 loan. If you decide to go this route, you would need to place 10% down. Another 40% of the total amount of the property would come from an SBA Certified Development Company, while the remaining 50% would come from a lender.

5) Hard Money Loan: Hard money loans, or “bridge loans,” are short-term loans that carry high-interest rates and short terms. Lenders that offer these types of loans make decisions not based on a borrower’s credit history but rather on the perceived value of the property. Investors typically utilize bridge loans to finance deals in the interim while negotiating for longer-term loans through a bank.

6) Online Marketplace Loan: Online marketplace loans, otherwise known as “soft money loans,” match aspiring borrowers to investors who can help finance the commercial property. In return, the investor shares in the property’s profits. These types of loans are often called “soft money loans” because, while the rates are higher than traditional bank loans, they’re not nearly as high as those associated with hard money loans. Soft money loans, like bridge loans, typically come with short terms of about six months to a few years.

Regardless of the type of loan you ultimately choose to use (except for a conventional bank loan), know that the lender is more likely to consider a property’s value over your credit history. Commercial properties offer impressive returns, so if an investor defaults on loan, lenders rest easy knowing they can seize the property resell it or lease it for additional profit.

That said, you should still do your home before selecting a commercial real estate loan that is right for you and your needs. For expert guidance, consult with an advisor today.