If you come from a background in residential loans, you’ll quickly learn how different commercial real estate loans are. In the residential world, lenders will compete for your business because they sell your loan to government agencies. These agencies include Fannie Mae, Freddie Mac, and the FHA. CRE lenders assume more risk and therefore are choosier when underwriting loans. It’s a good idea to understand what lenders require for CRE loans, and that’s this article’s purpose.
CRE loans have many advantages. You develop professional relationships that can last a lifetime, and you avoid many residential tenancy issues. As you’ll quickly discover, the hard part isn’t finding a suitable property or construction site. Rather, your toughest obstacle is to obtain CRE loans to finance your project. In this article, we’ll catalog the different types of CRE loans. Then, we’ll address some interesting issues regarding CRE loans and answer a few frequently asked questions.
How Do Commercial Real Estate Loans Work?
Commercial real estate loans are debt agreements between a borrower and lender. The borrower can be an investor, developer, or other party interested in building, buying, rehabilitating or refinancing CRE.
Terms of CRE Loans
The term of the loans can range from a few months to 30 years. Loans under five years are available with deferred principal. That is, you repay no principal during the life of the loan. Instead, you make a balloon payment of the principal balance at the end of the term. Typically, you pay off an interest-only loan with a more conventional amortizing loan.
Collateral for CRE Loans
For CRE purchasers, the existing property can serve as collateral for the loan. However, the loan might require additional collateral. Naturally, if you plan to construct new property, you’ll need to use other properties or cash as collateral. Depending on the loan, your down payment will usually range from 20% to 35% of the property value. However, CRE loans might have arrangements outside the normal parameters. An example is a mezzanine loan that can reduce your equity investment to 0%.
Do CRE Loans Have Fixed or Variable Interest Rates?
Unsurprisingly, the answer depends on the type of loan you secure. However, you’ll find that most CRE loans are variable-rate. Often, the CRE interest rate will be higher than that available for residential real estate loans. In some variations, CRE loans might start out as fixed-rate and then automatically become variable-rate after a set period.
Qualifying for CRE Loans
Again, the requirements for obtaining commercial real estate loans depend on the type of loan. Additionally, the source of the loan and the specifics of the project all play a role. Here are a few things to consider when applying for CRE loans:
- Credit History: Your credit score should be at least 680, but there are many exceptions. The reason is that some loans, such as hard money loans, focus on the property value instead. However, if you have a history of foreclosures, tax liens, bankruptcies or fraud, your chances of loan approval diminish.
- Loan-to-Value Ratio: This is equal to the loan amount divided by the value of the collateral. Typically, the LTV for CRE loans is in the 65% to 85% range. But you’ll find many deals with LTVs outside this range.
- Recourse vs Nonrecourse CRE Loans: In a recourse loan, the borrower must pledge personal assets to guarantee the loan. This is in addition to the collateral that the business entity puts up. The business entity will probably be an LLC, LP or corporation. In a nonrecourse loan, the lender cannot come after the borrower’s personal assets following a default. Not surprisingly, lenders prefer recourse loans, but borrowers would rather arrange a nonrecourse loan.
- Time Required to Get CRE Loans: This depends on the type of loan and the type of lender. Banks require huge amounts of paperwork and can take months to approve a loan. A loan broker like Assets America® can move more quickly. The hardest aspect of dealing with a bank is when, after months of deliberation, it rejects your loan. That’s one reason, among many, why Assets America® is a better choice for borrowers seeking loans of $5 million or more.
Types of CRE Loans
We classify loans along two dimensions. The first is the line of business, and the second is the loan type.
Lines of Business – Commercial Real Estate Loans
Here are the lines of business for available CRE loans through Assets America®:
- Bridge Loans: A short-term loan to acquire and improve CRE.
- Building Storage Units: Financing for self-storage facilities.
- Construction Loans: For building or reconstructing CRE.
- Energy Finance: Loans to finance energy projects.
- Hospital Building: For hospital acquisition, construction, rehab or refinancing.
- Hotel Financing: Loans to finance hotels, motels and resorts.
- Industrial Park: Construction or acquisition of industrial parks.
- Master Planned Communities: Loans for large, complex and multi-phased development of residential neighborhoods.
- Mixed Use Development: Loans for buildings with multiple uses.
- Multifamily Loans: For properties with five or more residential units.
- Office Building Loans: For office building acquisition, construction, rehab or refinancing.
Lines of Business – Additional Asset Classes
- Aircraft Financing: Loans for commercial and corporate aircraft.
- Ship Financing: Purchase, construction, refurbishing and refinancing of commercial cruise and cargo ships.
- Yacht Financing: Loans for yachts, super yachts and mega yachts.
Construction Loan Types
- Acquisition & Development Loans: Covers the cost of purchasing and developing land.
- Land Development Loans: Loans to develop raw land.
- Mezzanine Loans: Additional debt in the capital stack to free up cash.
- New Construction Loans: Short-term, interest-only loans to finance new construction.
CRE Loans Types
- Adjustable Rate Mortgage: The interest rate can vary over time.
- Balloon Mortgages: Payment of remaining principal due all at once at end of loan term.
- Blanket Mortgage: A single loan instrument encompassing multiple properties.
- CMBS Loans: Long-term conduit financing secured by a first-position lien.
- CRE Syndication: Loans provided by a group of investors.
- DIP Financing: Debtor-in-position financing, in which borrower still has possession of collateral.
- Fixed Rate Loans: The interest rate remains unchanged over the loan term.
- Gap Funding: A junior position loan that reduces cash requirement for the primary loan.
- Hybrid ARM: A mortgage that is initially fixed-rate but then converts to variable rate.
- Interest-Only Mortgage: Repayment of principal defers for a set period.
- Recourse Loans: Borrower pledges personal assets to back debt.
What Nobody Tells You About CRE Loans
Here are few interesting points:
Securing CRE Loans
It can be harder to secure a CRE loan than you might suspect, especially if you try to borrow from a bank. You might require far more patience and preparation than you planned. The reason is that CRE loan logistics are more complex and there are many moving parts. That’s why you want the support of a loan broker like Assets America®. We work hard to get you $5 million or more in financing as quickly as possible.
Maturity vs Amortization
In the residential real estate market, home mortgages mature and amortize on the same schedule. CRE mortgages are different. They might amortize over 30 years but mature in only 10 years. In other words, you repay the mortgage as if it has a 30-year term. However, you must make a final balloon payment in 10 years to repay the loan.
Non-Recourse Loans Are Worth Additional Equity
Suppose you receive this choice. On the one hand, you can get a CRE recourse loan by putting up 25% in equity. Conversely, you can get a CRE nonrecourse loan that requires a 35% equity contribution. Go with the latter, because you don’t want to gamble you personal assets. Things can always go wrong with a CRE project, but you needn’t go personally bankrupt. Whenever possible, take the nonrecourse route and protect your wealth.
Debt is Better Than Partners
If you are fiercely independent, the thought of dealing with partners might rankle. After all, do you really want somebody second-guessing your decisions, or worse yet, vetoing them? Therefore, see if you can afford to provide 100% of the equity required to obtain a CRE loan. If you want to call the shots, this is just the ticket.
Use an Experienced Lawyer
Sure, you need to know the legal requirements for a given piece of land and any property on it. These requirements include zoning laws, building codes, union rules, etc. But you really need to retain a legal eagle before you sign a CRE purchase contract. A shifty seller or predatory lender can introduce unwelcome variables into the deal that you might not catch. Hire an expert lawyer to comb through the agreements and ferret out any pitfalls.
It Gets Much Easier with Experience
Your first foray into CRE might seem unfamiliar and threatening. However, after you get one or two projects under your belt, you’ll find things get much easier. You will have learned about the many unforeseen contingencies that can surprise you during a CRE Project. You’ll also discover how important it is to work with an experienced lender, such as Assets America®. We are happy to share our decades of knowledge and experience with you to facilitate your CRE project.
CRE Loan FAQs
Why are CRE loans nonrecourse?
Some CRE loans are nonrecourse. This means borrowers don’t expose their personal assets to seizure should they default on their CRE loans. You might have a better chance of securing a nonrecourse loan from a motivated seller or an aggressive lender.
What are the differences between CRE loans and home loans?
CRE loans usually cost more, are more complex, and mature faster than home loans. You should expect to pay a higher interest rate on CRE loans compared to residential loans. There are many types of CRE loans, including interest-only short-term loans.
How long can you finance commercial real estate?
You can finance commercial real estate for as much as 10 to 30 years. Many takeout loans contain a 30-year amortization schedule but a 10-year payoff requirement. This requires a balloon payment after 10 years to pay off the remaining loan principal.
Can you turn residential property into commercial?
Yes you can. For instance, you might have a country residence that you use during the summer months. You can convert it to commercial property by renting it out to tenants, either short- or long-term. You might reap substantial tax benefits from doing so.