Understanding the Basics of Commercial Lending
Purchasing a property for commercial purposes is an investment that can be financially rewarding above all other real estate transactions. However, it is an endeavor that needs lots of cash. And even though it is a lucrative investment that can generate generous monthly cash flow, it is a daunting task to build wealth in commercial real estate without an abundance of funds. This is where commercial real estate loans come in handy. As an investor, learning the ropes of commercial real estate financing can help you seek the best rates and terms for your enterprise.
What is a Commercial Real Estate Loan, and How Does it Work?
As you may know, commercial real estate is property that is used to generate income. As such, a commercial property loan is a type of financing that is specifically designed to help you purchase a property that is purposely designated for business. A commercial real estate property may include any of the following:
- Manufacturing industrial properties
- Office spaces
- Retail spaces
- Special-use properties, such as self-storage facilities and car washes, among others.
Now that we understand that real estate loans are those that help you cover the high costs associated with purchasing a business property, how do they work?
Typically, commercial real estate lenders provide loans that are secured by liens of the property being purchased. This means that if an investor is unable to service the loan, the lender has the legal right to seize the property. Additionally, some lenders require that you make a downpayment on the loan you are asking for. A significant number of commercial real estate lenders require that you make a downpayment of between 20-30% of the property’s buying price.
Application Process/Time Frame
When getting ready to apply for a real estate loan, there are a few things that you need to put in order.
For starters, since a solid credit score is vital for this process, you should ensure that your financial ducks are in a row. Make sure that your credit score is at the minimum above 680. Ascertain that it doesn’t contain recent bankruptcies, foreclosures, and tax liens. A low credit score can spell doom for your loan application process.
Another important thing is to have a clear and detailed business plan. Lenders will intensely scrutinize what you intend to do with the property once you buy it. Have a clear outline of how you will utilize the property and a carefully thought out forecast of anticipated cash flow. Having the business entity set up before you actually fill out the application can make a huge difference.
Additionally, you need to tidy up your paperwork and ensure that it doesn’t contain things that may appear as red flags. Conveying a sense of preparedness will go a long way and something as simple as organized paperwork may be a determiner of whether you will get that commercial real estate loan or not.
How Long Does it Take to Get the Loan?
For most lenders, they estimate that the loan approval process should take about 30-45 days. However, experience dictates that most commercial mortgages take from 45 to 120 days to appraise the loan, but this doesn’t mean you won’t find exceptions. Nonetheless, if you are on a timeline, it is critical to understand that the process can take longer than expected.
Cash Flow Factors
As an investor, you should also understand other cash-flow factors that lenders consider when it comes to commercial real estate loans.
- Loan-To-Value (LTV) Ratio
Since commercial real estate loans don’t have private mortgage insurance, lenders usually use the property being bought as the collateral. Therefore, lenders largely depend on the loan-to-value ratio (LTV). This calculates the value of the loan against the appraised value of the property.
Loan-To-Value (LTV) = Mortgage Amount (MA)/Appraised Property Value (APV)
When the LTV is too high, lenders may not be willing to give you a loan as they view it as too risky. Typically, viable commercial real estate loans are those that have an LTV ratio ranging from 65-80%. Additionally, the LTV ratio is used by commercial lenders to determine the interest rate you’ll pay.
- Debt-Service Coverage Ratio
Another essential aspect that commercial lenders consider when offering commercial real estate loans is the debt-service coverage ratio (DSCR). To get this ratio, lenders divide the annual net operating income from a property by its annual mortgage debt service (principal and interest payments).
Debt Service Coverage Ratio (DSCR) = Net Operating Income/Total Debt Service
A DSCR of 1 or more indicates a positive cash flow. A ratio below 1 indicates a negative cash flow. Generally, commercial lenders usually require that a property should have a DSCR of 1.25 and above. However, some lenders may accept a lower DSCR if they offer loans with a shorter amortization, or find out that the prospective properties have a stable cash flow.
Commercial real estate loans also come with other charges besides the interest rate. You must be aware of the upfront fees that you are required to pay when getting a commercial loan. They include legal cost, property appraisal, loan origination, loan application, and survey fees. While some lenders may ask you to pay the fees upfront, others will bill them annually.
Commercial Loan Repayment Terms and Schedule
Commercial real estate loans are not like residential mortgages, which are often paid in regular installments over a fixed period. They come in two terms:
- Intermediate-term loans of 3 years or less
- Long-term loans that last for 5 to 20 years
The loans can also be classified as amortized or balloon loans. Amortized loans are paid in installment plus the interest until the full amount is recovered. On the other hand, balloon loans require you to make fixed monthly payments for some years and then pay in a lump sum to clear the remaining principal when the provided loan period expires.
The Meridian Real Estate Group Can Help
As you can see there are multiple factors that play a part in obtaining a loan for commercial real estate as well as many other components that are involved both before and after the loan process. If you’re an investor wanting to embark on this potentially lucrative journey, we can help. The Meridian Real Estate Group is a full service commercial real estate team servicing all of the main divisions of commercial real estate including Office, Industrial, Retail, Multifamily, and Land. We are also highly experienced in the process of land assemblage for large commercial land development projects. In addition, we can assist in finding commercial property for lease for your business or finding tenants to lease your existing commercial property. Our mission is to provide the highest level of service for all of our commercial clients and to aid investors in finding properties and negotiating deals to build a lasting commercial real estate legacy.