Getting into commercial real estate can be a very profitable business. As the demand for office and retail space continues to grow, many investors are considering owning commercial spaces to rent or sell. But financing a commercial property is often challenging and almost impossible using your savings. Therefore, many investors look for alternative ways to finance their commercial property purchases, renovations, and developments. Commercial property financing differs from residential property financing because it’s used to finance business-related activities. Commercial real estate loans are typically used to purchase or renovate commercial properties such as office buildings, warehouses, retail space, and multifamily housing complexes. Moreover, commercial financing is more expensive than residential financing because lenders consider it a higher risk. The fees, rates, and terms of commercial loans are often negotiable, which makes it important to shop around for the best deal. Here are some basics of commercial property financing you should know about.
Types of Loans
There are several types of loans available for commercial real estate investors. Each of the loan types has different features, terms, and requirements. The most common types of loans are:
- Commercial Bridging Loans: Commercial bridging loans are short-term loans that are used to cover cash flow gaps when financing is needed but isn’t available. For example, you can use bridge loans to finance the purchase of a new property before your current property is sold. Commercial bridging loans are typically repaid within one to two years and have higher interest rates than other types of loans. Many lenders can offer better terms and less strict requirements on this loan. For example, with Novellus, you can get commercial loans on specific circumstances around the asset and borrower, allowing for more flexible lending.
- Commercial Mortgages: A commercial mortgage is a loan used to finance the purchase or refinance of a commercial property. Commercial mortgages are typically repaid for five to 25 years and have an interest rate slightly higher than residential mortgages.
- SBA Loans: The Small Business Administration (SBA) offers several loan programs that can be used for commercial real estate financing. These loans are backed by the government and have lower interest rates than bridge loans. However, they often have strict eligibility requirements and long application processes.
- Hard Money Loans: Hard money loans are short-term loans backed by real estate collateral. These loans are typically used for fix-and-flip properties and have higher interest rates than other types. It’s the last resort for financing because of the high-interest rates and short repayment terms.
Interest Rates On Commercial Property Financing
Interest rates on commercial property financing vary depending on the type of loan, the lender, and the borrower’s creditworthiness. Commercial mortgages have interest rates between 5.57% – 8.57%, while Bridge loans have interest rates between 7.57% – 16.57%. SBA 7A loans have low interest rates starting at 4.50%, although the rates can rise as high as 8.00%. SBA 504 loans have interest rates between 5.32% – 5.45%. Knowing these interest rates can give you a better idea of what to expect when shopping for commercial property financing. However, it’s important to remember that these rates are only averages, and the lender will determine your actual interest rate.
Different Loan Ratios
Loan ratios are another important factor when shopping for commercial property financing. Loan ratios are the relationship between the loan amount and the property’s value. The ratios are often divided into two major categories:
Loan-to-Value Ratio (LTV)
The loan-to-value ratio is the loan amount divided by the property’s value. For example, if you’re purchasing a USD $100,000 property with a USD $50,000 loan, your LTV would be 50%. Lenders typically require a lower LTV for commercial loans because they’re considered higher risk. However, some lenders will finance up to 100% of the purchase price for certain types of properties.
Debt-to-Service Coverage Ratio (DSCR)
The debt-to-service ratio is the loan payment amount divided by the property’s income. For example, if your monthly loan payment is USD $2000 and the property generates USD $4000 monthly income, your DSCR would be 50%. It’s calculated by the ability of the commercial property to service its debt. The right DSCR should be greater than one because a lower ratio means the property isn’t generating enough income to cover the loan payments. Most lenders will pay a higher DSCR because the property is less risky.
Commercial Property Financing Terms
The term of the loan is also crucial in understanding commercial property financing. The term is the length of time you have to repay the loan, ranging from five years to 20 years. The longer the term, the lower the monthly payments, but the higher the total interest paid. Unlike residential property financing, lenders have an amortization period longer than the loan period. This means that if a lender gives out a loan with an amortization period of 20 years, the investor may be required to pay the loan in 10 years based on the amortization terms but then make one final balloon payment. For example, if an investor takes out a loan with a term of five years, but the amortization period is 20 years, they would need to make 60 monthly payments. At the end of the five-year term, they would make one final balloon payment to cover the remaining loan balance.
Commercial Property Financing Calculator
A commercial real estate loan calculator is a tool that can help you determine your monthly payments and the total interest paid on a loan. The calculator will consider the loan amount, interest rate, term of the loan, and amortization period. To use the calculator, you will need to input the property’s purchase price, down payment, loan amount, interest rate, and loan term. The calculator will then output the monthly payment amount and the total interest paid over the life of the loan. Using the loan calculator gives you insights into what you can afford and how much the loan will cost you.
Commercial property financing can be complex, but understanding the basics is the first step in making informed decisions. Be sure to consider all the factors involved in commercial property financing before making a decision. This will help you get the best loan for your needs. Also, remember to shop around for the best interest rates and terms.