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What Is a Real Estate Loan?

Realtors facilitated transactions for 48 billion square feet of commercial real estate in 2015.

That’s a lot of office buildings, retail centers, hotels, and restaurants.

A commercial real estate loan can help you pay for the high cost of owning and maintaining the property necessary for your valuable business.

If you are wise, you will build up a lot of equity after you take out your loan. It will grow as you repay your loan, especially if you can make a larger down-payment or pay down your principal faster. 

How can you get a commercial real estate loan, and which one is right for you? Let’s take a look.

What Is a Real Estate Loan?

A commercial real estate loan is a lien on commercial, rather than residential, property. It refers to a loan on any income-producing real estate that is used for business, such as those on this site.

Most commercial real estate lenders require that a property be owner-occupied. This means that the borrower and their business must occupy at least 51% of the building. The investor usually leases out the space and collects rent from other business owners on the property.

If you do not plan on taking up that much of the space, you can look into getting an investment property loan instead.

Commercial loans are secured by the property being purchased. When you are looking for one, know that your credit history will be examined. Banks are looking for borrowers with a strong business, good personal credit, and a low debt service coverage ratio. 

Lenders usually consider collateral, loan-to-value ratios, and personal trustworthiness. Be prepared to show them up to 3-5 years of financial statements and tax returns.

Real estate loans are usually made to entities formed for the specific purpose of owning commercial real estate. Very often, these entities are corporations, partnerships, developments, and Real Estate Investment Trusts (REIT.)

How Do Real Estate Loans Work?

The most popular type of residential loan is a 30-year fixed mortgage. Commercial loans, by contrast, can last anywhere from five to twenty years.

Unlike residential mortgages, commercial mortgages are often amortized, or gradually written off. The amortization period is often longer than the loan period.

For example, a lender might lend money to a borrower for seven years at a rate that would be appropriate for a 30-year fixed mortgage. The borrower makes these payments and then pays off the entire payment at the end with a final “balloon” payment.

Down-payments on commercial real estate loans can be anywhere from 10%-50%, as distinguished from residential mortgage down-payments that usually hover around 20%. 

Interest rates on these mortgages can be fixed, which means they will not change, or variable, meaning the rates will fluctuate depending upon underlying indexes. Commercial mortgage interest rates are usually a few percentage points of a prime rate, such as the Wall Street Journal (WSJ) prime rate.

The first basic payments on a commercial property are known as permanent mortgages. These mortgages must have a degree of amortization, as well as a term of at least five years, written into their contracts.

What Are Some Basic Commercial Real Estate Loans?

Traditional commercial mortgage loans can vary greatly, depending upon borrowers and lenders. Your bank could offer a fully amortized loan with terms up to 25 years. Other banks may have interest-only loans with terms of only 10 years.

SBA loans are backed by the Small Business Administration (SBA.) The 7(a) loan will allow you to borrow up to $5 million through an SBA lender. Interest rates vary, and repayment terms can be up to 25 years.

The SBA also offers a 504 loan. It requires about 10% down.

The 504 loan is actually a combination of two loans. You will get one from a Certified Development Company (CDC) for up to 40% of the loan amount. Over 50% of the loan amount will come from a bank. 

These loans are fully amortized, and the maximum terms on them are 25 years.

Conduit loans are pooled together by lenders and sold to investors in a secondary market. The minimum loan amount on conduit loans is between $1 million and $3 million. 

Most conduit loans are for 5 to 10 years, with 20 to 30-year amortization periods. There is high security with these, so expect your financial background to be scrutinized.

What Other Types of Commercial Real Estate Loans Are Available?

Bridge loans are often used to fill the gap while investors are looking to secure more long-term financing for their business properties. They are often used by folks trying to renovate properties who wouldn’t qualify for traditional loans before they sold them.

Bridge loans can last anywhere from 6 months to three years. They require a low down-payment of 10%-20%. Most bridge loans close more quickly than conventional commercial loans.

Hard money loans are similar to bridge loans. They are made by private companies and require higher down-payments. Most hard money loans have shorter terms, higher interest rates, and some interest-only payments.

Generally, it is easier to qualify for a hard loan than a bridge loan. You will also be able to get the funds more quickly.

Soft money loans offer lower interest rates, lower down-payments, and longer terms than hard money loans. Because they are more desirable, your credit history will be scrutinized more closely. Soft money loans are a good option for borrowers who need quick access to funds and do not wish to pay the higher interest rates of other loans.

Getting Down to Business

A commercial real estate loan can be a wonderful investment in the future of your enterprise. Choosing the right loan for you can result in the flourishing of your brand and services.

For more information on small business, read our blog today.