Buy, refinance, build or tap equity in commercial properties
A commercial property loan, or commercial mortgage, is a specific finance option to purchase land or a property that is used for businesses or to produce income. Commercial real estate includes industrial, retail and office properties as well as mixed-use properties, restaurants and multifamily properties with five units or more.
In addition to purchase loans, there are a variety of commercial mortgage loans that can help owners refinance their mortgages, tap into equity, or constructs new commercial properties.
1.2 or higher
If you’re seeking financing to purchase a commercial property, there are a few factors that will affect your eligibility for a loan.
Underwriters evaluate whether you have sufficient collateral to cover the loan. For a mortgage, the collateral is typically the borrower’s equity in the purchased property. Borrowers can increase their equity in the property by making a larger down payment. This decreases the loan-to-value ratio (LTV), one of the factors underwriters use to help make lending decisions.
For additional security, lenders may require you to assign to them rents and/or leases. If you default on the loan, the lender would be entitled to any rental or lease income the property produces.
Because commercial properties are meant to produce income, the amount of cash flow may affect whether a commercial mortgage is approved. Loan underwriters look at the property’s past income, and more carefully at the past 90 days’ income. Lenders also look at the property’s debt service coverage ratio (DSCR) — the net operating income divided by the property’s total debt service. Lenders typically prefer a DSCR of 1.2 or higher.
The borrower’s credit history — whether it’s an individual investor or a company — can affect whether your loan is approved. In general, to be approved for a commercial mortgage, you must have a credit score of at least 660. You must have no tax liens or judgements, short sales or foreclosures against you, and you must not have filed for a personal bankruptcy in the past seven years.
There are myriad financing options for commercial real estate, each with its pros and cons. Consider the features of each loan type before applying for financing.
Some commercial real estate loans are backed by federal agencies. The loans are offered by financial institutions such as banks, and are guaranteed by the government. Federal agencies offering government-guaranteed commercial real estate loans include:
Conventional loans conform to the standards of the two government-sponsored enterprises: Fannie Mae and Freddie Mac. These loans, which are only available for multifamily properties, are commonly offered by direct lenders, such as banks or credit unions, which sell the loans on the secondary market to Fannie and Freddie.
Both enterprises offer loan programs that can be used to finance the purchase, construction or refinance of multifamily properties. Many are geared toward specific types of housing, such as properties designed specifically to house students or seniors.
Hard money lenders are typically made up of a group of private investors, while private money lenders may be single individuals willing to loan their own money for the purchase of a commercial property.
These nontraditional loans tend to place less emphasis on the borrower’s credit score than on the value of the property being purchased. This can be beneficial if you have poor credit. These loans also tend to close faster. The tradeoff generally is higher interest rates and shorter terms. Because of the short terms, these loans often must be refinanced into longer-term financing to avoid issues such as large balloon payments.
Life insurance companies increasingly are becoming major players in commercial real estate lending. Companies often offer attractive rates and other loan terms, but also tend to be uncompromising in their standards. Typically, only borrowers with stellar credit and other favorable factors qualify for a commercial mortgage through a life insurance company.
A commercial mortgage-backed security (CMBS) is formed when several commercial mortgages are combined into a security, and then the security’s shares are sold to investors. By combining several kinds of loans, CMBS loans — also known as conduit loans — allow banks to issue more loans and offer investors higher yields.
Because lenders see commercial real estate loans as riskier propositions compared to residential real estate loans, interest rates on commercial loans are often higher than residential loan rates. That said, a number of factors influence commercial loan rates.
Different types of lenders offer different interest rates. Life insurance companies, for example, often offer lower interest rates, but are more difficult to qualify for. Hard money loans typically have higher interest rates, but are easier for borrowers with bad credit to qualify for.
Most commercial real estate loan terms are short — typically five to seven years, with a balloon payment due at the end of the term. Though less common, some lenders offer commercial real estate loans with fully amortized terms, from 20 to 30 years. HUD’s 221(d)(4) loan program is an example of a fully amortized commercial loan program.
Your loan-to-value (LTV) ratio is the loan balance divided by the property’s market value. The higher the LTV, the lower your interest rate will typically be. Increase the LTV by making a larger down payment. This increases your equity in the property and lowers the amount you actually borrow.
If a borrower defaults on a recourse loan, the lender may seek to collect the difference between the proceeds of any collateral, and the remaining balance on a loan.
When a borrower defaults on a nonrecourse loan, however, the lender is not able to collect the difference between what is owed and what they can recoup through collateral.
As with any loan, commercial real estate loans come with a variety of costs and fees you should take into account before signing on the dotted line.
Upfront costs and fees associated with commercial real estate loans can include an application fee and the cost of an appraisal or survey. These costs often can be rolled into the loan balance.
Lenders typically charge an origination fee equal to 1 percent of the total amount of the loan. Other closing costs can include environmental or inspection report fees, title insurance, and other miscellaneous fees, such as processing, credit report or documentation preparation fees.
Lenders loan money to make money, primarily in interest. When loans are paid off early, lenders don’t make as much money in interest as they would have if the borrower had made payments throughout the entire loan term. For this reason, lenders may charge prepayment penalties. It’s also called defeasance fee or an interest guarantee. The lender may also simply prohibit you from paying off the loan early.
Refinancing a commercial real estate loan can save you money if your new loan has a lower interest rate than the original mortgage. A refinance cash-out could allow you to borrow more money than the original mortgage and receive the difference in cash.
The downside of refinancing is the potential costs associated with it. Take these costs into account to ensure refinancing will actually save money.
If you have a lot of equity in your commercial real estate property, you may be able to get cash out of that equity with a loan or line of credit.
Typically, construction loans on commercial properties require two rounds of financing. A short-term loan finances the construction, and a second, longer-term loan pays off that construction loan after leases have been signed and the property has been stabilized.