When taking the leap into the arena of commercial real estate many small business owners and investors are surprised by the differences between commercial lending and residential lending.
Commercial real estate lending is a more complicated form of financing that requires a completely different set of lenses through which to view the lending process. If you are considering the acquisition of commercial property, start with the basics.
Commercial Mortgages are Different
Commercial mortgages are not regulated in the same ways that residential ones are so there are fewer built-in consumer protections. Also, unlike residential loans, the terms for commercial mortgages are somewhat stricter for the borrower:
- The loan term is usually of shorter duration
- The amortization period is usually 7, 10 or sometimes 20 years, but rarely 30 years
- The amortization schedule and the loan term may not match, leaving a balloon payment due at the end of the term
- Interest rates are often variable, not fixed so the risk of interest rate increases is on the borrower’s shoulders
- The lender may require you to personally guarantee the loan even if it is a business debt
- You’ll need a substantial cash down payment or equity in the property
Obtaining Commercial Loans
To find financing, you can go to your bank or you can use a commercial mortgage broker. There isn’t a right or wrong answer to this question. It depends entirely on your financial circumstances and the type of loan terms you want.
A commercial broker should have access to a variety of lenders, including banks. So that can be a one-stop shopping experience. They also often have access to lenders who are willing to take on riskier properties, which banks tend to avoid.
A good commercial broker can offer you a number of options and terms, but definitely research the broker. They are regulated by the states, but some states don’t really regulate them much at all. You want to make sure you are dealing with a reputable firm before proceeding.
Bankers like sure bets, so they are generally less flexible in their terms and only want to deal with very strong candidates. If you have a good relationship with your bank, the commercial property you are considering has a solid cash flow and you have a strong personal financial profile, your banker is going to love seeing you walk in the door. And you’ll most likely get good terms.
If you’re not the ideal candidate, you will be looking at higher rates and possibly a more substantial down payment.
Commercial Mortgage Loan Documentation
Documentation will be your middle name when doing a commercial loan. Not only will you need the financial history and projections for the property, you’ll need your financial history and financial statements as well. Then there are the appraisals and the surveys and the title search and the environmental inspections….in short, this doesn’t happen overnight. You’ll need time for your due diligence and also to collect and submit all the necessary documentation required.
It’s All About the Numbers
Commercial lending is based on financial history and projections. Whether or not there is sufficient cash flow to service the loan is really the lender’s primary interest. You may think it’s a great investment opportunity, but the lender will take a conservative approach to your projections.
So if you are buying investment property like an apartment building, the property’s financial statements have to realistically show sufficient cash flow for debt payments. If you’re buying property to house your business, it will entail showing that the business itself is profitable and has sufficient cash flow to pay off the loan.
Commercial Mortgage Loan Applications
Start talking to lenders early in the process of purchasing. Before you get too far into the purchase, you’ll need to know whether you have a reasonable prospect for obtaining the financing you need.
There are lots of considerations when obtaining a commercial real estate loan. The key is that you know the reasons why you want to own commercial property, understand how much cash flow you will need to pay the loan and make sure you understand all the terms of the loan before you sign on the dotted line. With any commercial transaction, seeking legal advice is the smart move before signing anything.