A Guide to Securing Commercial Property Loans

Securing a commercial property loan is a crucial for any business looking to invest in real estate. These loans provide the money needed to purchase, develop, or renovate commercial properties, which can help you grow your business.

This guide shows you how to get a commercial real estate loan. It covers everything from preparation and application to approval and closing. You’ll learn how to compare loan options, prepare the necessary documentation, negotiate terms, and empower business owners to make smart decisions.

In this article:

• Understanding commercial property loans
• Prepare thoroughly by assessing your financial health, improving your credit score, and having a solid business plan.
• Compare lenders carefully and negotiate terms to secure the best possible loan for your business needs.

What Are Commercial Property Loans?

Commercial real estate financing is designed to help businesses acquire, develop, or refinance commercial real estate. These loans can be used for office buildings, retail spaces, warehouses, and multifamily housing. Unlike residential loans, commercial property loans typically have stricter borrower qualifications and higher interest rates because they involve more risk.

Types of Commercial Property Loans

There are four main types of commercial property loans:

Traditional Commercial Mortgages

Traditional commercial mortgages are loans offered by banks and other financial institutions to buy commercial real estate. These loans can be either fixed-rate or adjustable-rate.

• Fixed-rate mortgage: has the same interest rate for the entire loan term. This means you have predictable monthly payments.
• Adjustable-rate mortgage (ARM) starts with a lower interest rate that changes based on the market.

The terms and conditions of traditional commercial mortgages vary, but they generally require a large down payment (20% to 30%) and a good credit history.

SBA Loans

The Small Business Administration (SBA) backs loans for small businesses. Two types of SBA loans can be used to purchase commercial property: the SBA 7(a) and the SBA 504 loan.

• SBA 7(a) loan: Can be used for real estate purchases, renovation, and working capital.
• SBA 504 loan: Specifically for purchasing fixed assets like real estate and equipment.

Both of these loans offer favorable terms, such as lower down payments, longer repayment periods, and competitive interest rates. That being said, they have strict eligibility criteria and require a lot of paperwork.

Related: Can You Get a Small Business Loan for Real Estate?

Bridge Loans

These short-term loans provide immediate cash while long-term funding is being secured. These loans “bridge” the gap when a traditional loan would take too long. Bridge loans have higher interest rates and shorter repayment terms (usually six months to three years) than traditional mortgages.

Businesses use bridge loans to quickly purchase a property, complete renovations, or take advantage of a time-sensitive deal. Because they are temporary and have high costs, bridge loans are best for borrowers who have a clear path to long-term financing.

Hard Money Loans

Hard money loans are short-term loans from private lenders. They’re used by real estate investors who need fast access to funds for property purchases, renovations, or other investments. Hard money loans are secured by the property itself, making them easier to obtain for borrowers with less-than-perfect credit.

Hard money loans come with higher interest rates (often 10-15%) and shorter repayment terms (usually one to three years). Because of their high costs, hard money loans should be a tool of last resort or a tool for experienced investors. (If you’re curious how to find a hard money lender, try searching “hard money lender near me” and see what pops up).

You may also like: revenue based financing for commercial properties

Loan Eligibility Criteria

Eligibility for a commercial property loan can vary by lender but usually includes:

• Credit Score: Most lenders require a credit score of at least 650, but higher scores can get better terms.
• Business History: Lenders prefer businesses with at least two years of proven success.
• Debt-Service Coverage Ratio (DSCR): This measures your ability to repay debt. Most lenders require a DSCR of at least 1.25.
• Down Payment: Most commercial loans require a down payment of at least 20-30% of the property’s purchase price.

How to Assess Your Eligibility

Checking your eligibility for a commercial property loan involves reviewing your finances and making improvements where you can. Here’s a step-by-step guide:

Check Your Credit Score

Start by reviewing your credit score. A higher credit score increases your chances of securing a loan for real estate with favorable terms. Aim for a score of 680 or higher, but note that lenders may require a score of 700 or above for commercial loans. If your score is lower, pay down any existing debt and correct any errors on your credit report.

Analyze Your Business Financials

Gather your income statements, balance sheets, and cash flow statements. Lenders will use these to check your business’s financial health. Make sure you have stable income, healthy cash flow, and a manageable level of debt.

Evaluate Your Debt Service Coverage Ratio (DSCR)

Your debt service coverage ratio is how lenders determine your ability to repay a loan. It is calculated by dividing your business’s annual net income by annual debt obligations. If your DSCR is lower than 1.25, increase your net income or reduce debt.

Use our Debt Service Credit Ratio Calculator to help estimate your DSCR.

Ensure a Solid Financial Foundation

Don’t just try to meet the minimum requirements for a loan, try to show a strong financial foundation across the board. This means keeping a healthy cash reserve, having a diversified revenue stream, and showing a history of profitability. Lenders prefer businesses that are financially stable and have a low risk of default.

Develop a Clear Loan Use Plan

Prepare a detailed plan for how you intend to use the loan funds to generate revenue and grow your business. This plan should include projections for increased income, cost savings, or other financial benefits resulting from the loan. A well-thought-out plan demonstrates to lenders that you have a strategic approach to using the funds effectively.

Tips Before You Apply

Before applying for a commercial property loan, you need to prepare. This will save you time and increase your odds of getting good loan terms and conditions. Follow these tips to get started:

• Review Your Finances: Make sure your business’s financial statements are up to date and reflect stable cash flow.
• Write a Business Plan: Lenders want to see how you’ll use the loan to grow your business. Make sure your plan includes financial projections and shows how you’ll pay back the loan.
• Improve Your Credit: Pay off debt, pay bills on time, and correct any errors on your credit report. Improving your credit score can help you secure better loan terms.

Choosing the Right Commercial Property

The property you buy can affect your loan terms and the success of your investment. Prime locations tend to increase in value and attract higher rental incomes. Older properties may require more maintenance, reducing your profit.

Different property types have varying risk profiles. For example, retail spaces might have higher risks than office buildings, affecting the interest rate and loan-to-value ratio you can secure. So make sure you invest in properties that help you meet your goals.

Related: 9 Reasons Small Businesses Should Invest in Commercial Property

Finding the Right Lender

Shop around to find the best lender for your needs. Look for one that has experience with real estate loans. They should also have good reviews from customers. Ask if they’ve worked with other small businesses in the area and research their reputation.

You’ll also want to compare their interest rates, loan terms, and fees. These can vary greatly between lenders.

Pros and Cons of Different Lender Types

Type of Lender

Pros

Cons

Traditional banks

Competitive rates and lots of experience with CRE loans

Stringent requirements and longer approval process

Credit Unions

Lower rates and fees, experience serving SMB customers

Limited geographic reach

Online lenders

Quicker approval process and flexible terms

Can carry higher rates and fees

Specialized Commercial Lenders

Tailored products to CRE and higher loan amounts

Strict requirements and limited accessibility

The Application Process

Here’s a basic outline of the application process:

1. Pre-Qualification: Get an estimate of loan terms by providing basic info.
2. Submit Application: Submit your application with all required documentation.
3. Loan Underwriting: The lender reviews your financials, business plan, and the property details.
4. Approval and Commitment: If approved, you’ll receive a commitment letter outlining the loan terms.
5. Closing: Sign final documents and pay closing costs.

Common Mistakes to Avoid

When applying for a commercial real estate loan, it’s important to avoid these common mistakes:

• Incomplete Documentation: Make sure everything is accurate and up to date.
• Inaccurate Forecasts: Provide realistic revenue projections—exaggerating can hurt your credibility with lenders.
• Misunderstandings: Review all loan terms and conditions to clarify things like interest rates, repayment schedules, and fees.

Taking these steps will help you navigate the CRE loan application process smoothly.

How to Negotiate Favorable Loan Terms

Here are a few ways to negotiate favorable terms on a commercial real estate loan:

• Get Professional Advice: Consult a financial advisor who specializes in commercial real estate. They can give you tips and help negotiate on your behalf.
• Negotiate More Than Interest Rate: While cost is important, it’s not the only item to negotiate in your CRE Loan. You can also discuss flexible repayment schedules, loan term lengths, and prepayment penalties.
• Offer Collateral or Guarantees: If you offer additional collateral or personal guarantees, you can get better terms.
• Highlight Your Experience: If you have experience managing similar properties, highlight this to the lender.
• Build a Relationship: A good relationship with your lender can lead to better terms because they’ll know and trust you.
• Be Prepared to Walk Away: If terms aren’t favorable, don’t be afraid to walk away and try other options.

Closing the Loan

Closing on a commercial property involves several steps. First, you’ll review all the paperwork carefully. This includes the loan agreement and legal documents that outline the terms of your purchase. Make sure everything matches what you agreed on during negotiations. Take your time to understand each document fully before moving forward. There’s no pressure here to go fast.

Once you’re satisfied with the paperwork, sign the necessary documents. This step formalizes your agreement and makes it official. You’ll need to sign multiple forms, so don’t hesitate to ask questions if anything is unclear.

You’ll also need to pay the closing costs. These fees typically include loan origination fees, appraisal costs to assess the property’s value, and legal fees for document preparation and review. Make sure to budget for these costs ahead of time.

After signing the documents and paying the fees, ownership of the commercial property officially transfers to you. This means you gain all rights and responsibilities associated with owning or financing the property.

Keeping open lines of communication with your lender is essential for addressing any questions after closing.

Conclusion

Now you should have a basic understanding of how to purchase commercial property. It’s a complex process, but with thorough preparation and understanding, you can apply for a commercial real estate loan and have confidence that you’ll be able to secure the financing you need to achieve your business goals.

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FAQs

1. What are the main types of commercial property loans

   The main types include traditional commercial mortgages, SBA loans, bridge loans, and hard money loans.

2. What do lenders look for when approving a commercial property loan?

3. Lenders will evaluate a borrower’s financial health by analyzing their credit score, business history, DSCR, and down payment capability.

4. How can I improve my chances of getting a commercial property loan approved?

   Maintain a strong credit score, have a solid business plan, and ensure your financial statements are accurate and up to date.

5. Are there any specific challenges in securing loans for commercial properties compared to residential properties?

   Yes, commercial property loans typically have higher interest rates, more stringent borrower requirements, and a more complex approval process compared to residential loans.

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