Guide to Most Common Types of Commercial Real Estate Loans
If you're considering investing in commercial property, you should start exploring financing options as early as possible. Commercial real estate loans come in more varieties than their residential counterparts, and knowing what to expect when investing in property will help you focus your search and save you from possible heartache down the road.
Since businesses can fail, commercial real estate loans generally have stricter lending rules and higher interest rates than home loans. However, they vary widely depending on your own financial circumstances and those of the occupying business.
Here, we answer the six most common questions about commercial real estate loans:
1. What are the different types of commercial real estate loans?
There are three basic types of commercial loan financing: traditional loans, government-backed Small Business Administration (SBA) loans, and private loans. For all of them, the business or businesses must occupy at least 51% of the square footage.
Traditional loans: These come from banks, which examine your own credit history and that of the business. The longer the business has been around and the more profitable it is, the better your chances of getting a loan are.
SBA loans: These are ideal options if you have been denied traditional funding. There are two types of these loans: an SBA 7(a) loan or a DC/SBA 504 loan. A 7(a) loan can be used by commercial real estate investors who don't own a business in the building. For a CDC/SBA 504, you need to be an owner/occupant and your business must create jobs in the community. The SBA doesn't actually make these loans, but works with approved lenders that follow its guidelines. Qualification requirements are strict.
Private loans: Also known as bridge or hard money loans, private loans carry higher interest rates and are usually for short duration and special circumstances, such as buying a fixer-upper or obtaining funds while you improve your credit rating enough to get a traditional or SBA loan.
2. What's the duration of a commercial real estate loan?
These can range anywhere from five to 25 years. Lengthy loans are risky for banks, so the longer the term, the tougher it is to qualify. Shorter-term loans often require a "balloon" payment of the balance at the end. Another important point to note: Many commercial real estate loans carry stiff penalties for making extra principal payments or paying off the balance early.
3. What are the interest rates?
For traditional loans, you can expect 4.75% to 6.75%. SBA 7(a) loans range from 7.75% to 10.25%, and CDD/SBA 504s currently range from 4.64% to 4.94%. Private hard money and bridge loans, which have terms ranging from six months to five years, can be as high as 30%.
Of course, interest rates fluctuate, so keep checking during your search, especially if the Fed has a rate hike.
4. What about the down payment?
For a traditional bank loan, you'll need to put down 15% to 35% of the purchase price. CDD/SBA 504s require 10% down, and SBA 7(a)s range from 10% to 15%. For a bridge or hard money loan, you'll need to put down 35% to 50%.
5. Will I qualify?
A traditional bank loan usually requires you to have a credit score of at least 700. The occupying business also needs a solid credit score, and must have been in operation for at least a year or two.
SBA loans require a credit score of 680 or higher. For a 7(a) loan, the business must have been in operation for three years. A CDD/SBA 504s can be used for startups, but they need a strong credit rating and excellent financials.
6. How long does it take to get a loan?
Though most will tell you to plan for a time frame of 30 to 45 days, you should really expect closer to 45 to 120 days. Since businesses have many variables, calculating their value is notoriously complex.
If you can accept the higher interest rates and feel confident about a quick turnaround and sale—or a transition into a longer-term loan—you can get a bridge or hard money loan in as little as a week or two.
You should do as deep a dive as possible into the finances and business plan of the occupying business before making an offer. Of course, the bank will do the same thing if your offer is accepted, but doing your own analysis will lead to a better-informed decision and prepare you for judging future commercial investments.