Whether you’re looking to establish your business in a major metropolitan center or a suburban hub, commercial real estate financing options have never been better for small business owners. We’ll tell you about some of the choices available for your business to help you make the best decision.
Commercial property demand is at an all time high. According to research from the Commercial Real Estate Development Association, an estimated 523.5 million square feet of commercial property commenced construction in 2017, supplementing the 46.4 billion square feet of commercial space already existing.
If you’re a business owner looking to expand or simply seeking to relocate to a high traffic hub, you’re going to need to look at commercial real estate; and subsequently, you’re going to need to look at lending options. There’s numerous sources available, both traditional and non-traditional. But which is the best for you? There’s a few things you need to take into consideration first.
Types Of Commercial Real Estate Loans
Much like commercial real estate property, commercial real estate loans aren’t a one-size-fits-all, garden variety type of loan. The loan that best suits you is contingent on numerous factors; your needs as a business owner (e.g., space, employee size, inventory), availability of property, credit eligibility, rates and fees can influence the process.
Owners who are simply looking to invest in a property—meaning that their business is not looking to occupy the vast majority of the property—should reconsider commercial real estate financing. There’s a number of more suitable options available; in particular, investment property loans.
Terms and rates on commercial real estate loans vary depending on both property, credit and lender. Down payments on property can be anywhere from 10 to 50%, with repayment terms ranging from 5 to 25 years and include both fixed and variable interest rates. For non-established businesses, many traditional commercial real estate loans may prove a difficulty based due to both historic lending policies as well as sales history. But for established businesses, the options can certainly be attractive enough. Let’s look at a few of the more popular ones.
Traditional Commercial Real Estate Loans
Traditional Commercial Mortgage
A traditional commercial mortgage loan is similar to a standard residential mortgage loan. It’s a standard commercial loan issued by a bank and used for purchasing or refinancing property, and typically what people think of when commercial real estate lending comes to mind. These are typically the most desirable types of commercial real estate loans because the lending capital is significant, and with comparatively low interest rates.
But for many small business owners, a traditional commercial mortgage is hard to come by. Chiefly because they’re reserved for established businesses who have either shown substantial profitability or can accurately predict a high sales volume in the future. Banks also require a strong credit history, which means that many small businesses may find themselves ineligible.
Another barrier many small businesses may find with traditional commercial mortgage loans is that many banks don’t just want to see sales volume and credit ratings; they want to see your experience in business management. A high credit score and a successful first year run may not simply be good enough. Your chances are higher if your business is not only well established but has a sufficient sales volume to justify your need for expansion.
The Small Business Administration (SBA) is a federal agency which assists small businesses and entrepreneurs by incentivizing commercial lenders to approve affordable capital funding. Like commercial banks, an SBA loan is substantially more difficult to find approval for if you’re a small business without a strong commercial history and credit eligibility.
There are two types of SBA loans: an SBA(7)a loan and an SBA 504 loan. An SBA(7)a loan has a maximum borrowing limit of $5 million with flexible interest rate options and repayment terms up to 25 years. A 504 loan comes from two different sources; a Certified Development Company (CDC) which lends up to 40% of the loan amount and a bank or lending institution, which is responsible for up to 50% of the amount. While a 504 loan has a higher borrowing limit ($5 to 10 million depending on the terms) and variable interest rate options, you are required to place a down payment of at least 10% on the loan.
Non-Traditional Commercial Real Estate Loans
The very term non-traditional commercial real estate loan may be a bit misleading, as they’re are just as popular as traditional loans; and perhaps because of their flexibility, can be more appropriate for small businesses who have a need for quick expansion without a lengthy approval process. However, since they’re frequently administered by alternative sources (commercial asset lenders and private investors for example) and also have shorter terms of length, they don’t necessarily follow the same procedures as traditional commercial property loans.
Commercial Bridge Loans
A commercial bridge loan is a short term investment loan of anywhere from six months to two years, and are designed to help business owners purchase or lease property immediately until long term financing is secured. Because both risks and interest rates are higher, commercial bridge loans are also typically reserved for businesses who have a solid history of sales volume and credit eligibility who can ensure that the loan will also be paid back in a relatively short time; either in full or, more commonly, by refinancing a line of credit.
One advantage of bridge loans is the relatively low down payment requirement. Typically speaking, these fall between between 10% and 20%—compared to the 20 to 35% down payment required by commercial mortgage real estate loans. But while banks will occasionally offer commercial bridge loans, the risks involved (e.g, future profitability, immediacy of the loan) are better reserved for alternative lenders. Generally speaking, alternative lenders offer faster approval times and can be somewhat more flexible in repayment options. However, the guarantee of your approval can also depend on business history and credit.
Hard And Soft Money Loans
The purpose of a hard money commercial real estate loan is somewhat similar to a commercial bridge loan; a short term investment designed to help small business purchase commercial property immediately to help bridge the gap until long-term financing is found. However, the source of hard money loans almost universally comes from private lenders and investors.
The typical loan terms for both commercial bridge and hard money commercial real estate loans is relatively similar; between 1 to 3 years. However, interest rates can be higher—anywhere from 8 to 13%—with hard money loans (the average interest rate for a commercial bridge loan is between 7 and 9%.) And because they’re lent from private institutions, the down payment is by default relatively higher; anywhere from 15 to 35%. However, because they’re sourced by private entities they’re not only easier to qualify for than commercial bridge loans; they also have a faster closing time.
A soft money commercial real estate loan can be thought of as a hybrid combining elements of conventional loans with hard money loans. While administered by commercial lenders and banks instead of private institutions, they offer a considerably lower down payment and interest rates as a hybrid loan. Yet the same stipulations on credit ratings and business sales history apply as with traditional loans from commercial lenders
Also known as a Commercial Mortgage Backed Security loan, a conduit loan is a commercial mortgage loan which is pooled with other commercial loans and sold to secondary investors. The pool is held as a trust and function as a collateral for the securitized mortgage. Loan rates are offered as a permanent fixed rate mortgage similar to a traditional commercial mortgage loan, but segmentalized into different parts based on risk, maturities and returns. Most conduit lenders will request that the minimum loan of a CMBS be between $1 and $5 million.
Commercial Real Estate Loan Terms And Repayment Options
One of the most substantial differences between traditional and non-traditional commercial real estate loans is the repayment schedule. Both bank and SBA administered loans tend to be fixed rate mortgages, on terms of anywhere from 5 to 25 years and delivered through monthly installation payments. However, hard and soft money loans, as well as bridge loans, are on a much shorter term; typically 1 to 5 years, but with a much higher down payment and are fairly inflexible when it comes to refinancing options.
A balloon loan is one particular short-term commercial real estate option, where low-interest payments are made throughout the term of the loan (usually between 5 to 7 years) with the full balance due at the end. While payment schedule is at a fixed rate on a monthly basis, it does not cover the entire repayment of the loan. Traditionally, only interest and a portion of the initial balance is paid off during the course of the loan; with the final payment covering a significantly high amount. As a result, this type of loan is better intended for businesses who anticipate quick profitability with small initial capital.
Commercial Real Estate Loan Amounts And Rates
As with all capital real estate investments, commercial real estate capital amounts can vary dramatically, based on both the history of a property’s value, projected profitability and lender terms.
Loan-to-value is the size of a commercial real estate loan relative to the value of a property. Commercial lenders and banks typically have a maximum LTV cap of 90%, whereas hard money lenders and non traditional sources may only cover 50% or 60% LTV. Which means the remaining balance would have to be provided as down payment by the borrower. However, a general rule of thumb is that the higher the amount of your down payment is, the lower your interest rates will be.
If you’re planning on renovating a property, some lending sources will also calculate the after repair value (ARV), which can also impact the amount of your loan. Both banks, commercial lenders and non traditional sources will generally cover only up to 70% of the ARV as anything higher is considered too volatile in value to prove low risk.
Commercial Real Estate Costs and Interest Rates
Ultimately, the cost of a commercial real estate loan depends also on numerous factors which will influence both capital and interest rates—not the least of which will be both the sales history of your business as well as both personal and business credit and projected sales volume. A business that can make a sturdy case for loan approval from a traditional bank and commercial lender will typically find lower interest rates hovering between 5 and 7%. Hard money sources can charge anywhere from 10 to 20%—even for established businesses. However, because the approval requirements are less stringent than with traditional banks, you may find that projected revenue for a business can often justify the increase.
Fees for a commercial real estate loan can also vary according to lender. These can include application fees, origination fees, appraisal and surveyor fees, legal costs and annual fees. While this may only represent a small portion of the total loan cost, they can easily cut into both scheduled budget costs and your initial down payment.
Does My Business Demand It?
With such wildly variable types of loan sources, terms and payment options, you may very well be asking yourself whether or not your business is ready to take the leap towards purchasing commercial real estate property. And while that’s an answer only you can justify, the bottom line remains the need for your business to expand.
Even in today’s digital landscape, few businesses can afford to be without a physical presence. In a time when competition has never been greater (and resource options never more plentiful,) the question isn’t should you; the question is when? And from whom?
There’s no universal solution for commercial property options. You may find that your immediate need to purchase may ultimately pay off greater on a short term level if choosing a non traditional commercial loan than from a traditional bank or government agency. But as risky as a commercial real estate investment may be, it’s just as risky to rely solely on one source. And in today’s climate… that’s a risk you can’t afford.