If you own a business and are looking to expand or renovate, you’ll likely need to get a commercial real estate loan. These loans are very different from other types of small business loans, functioning more similarly to a residential mortgage.
Commercial Real Estate Loans Explained
Just like when you buy a house and take out a mortgage, you can also take out a mortgage when buying commercial property. Commercial real estate loans let businesses purchase or renovate property and finance this through a loan. Most commercial real estate loans require that the property be owner-occupied, meaning that the business needs to physically reside in at least 51% of the building. If the property will not be majority owner-occupied, borrowers can look for an investment property loan instead.
These loans can be used by a variety of businesses to finance different types of properties, including: office buildings, retail or shopping centers, apartment buildings, hotels, restaurants, or industrial buildings. Depending on what kind of property is being financed and what lender is used, terms and rates on these loans can vary widely (see our guide on average commercial real estate loan rates for a better idea). For instance, down payments on commercial properties can range from 10% to 50% or more, with repayment terms as short as five years and as long as 25. Some loans are fully amortized, whereas others might have interest-only payments with a final balloon payment at the end of the term. Interest rates may be fixed or variable.
Types of Commercial Real Estate Loans
A variety of commercial real estate loans exist from bank loans to SBA loans to bridge loans. We take a look at some of these options below.
Traditional Commercial Mortgage
Most banks and other lenders provide commercial real estate loans for a variety of properties, including office buildings, industrial buildings, multi-family units and retail centers. In most cases, the property will need to be owner-occupied.
Like a residential mortgage, the commercial loan will be secured by the property being purchased. Beyond that, terms vary widely depending on the lender. Some banks will make fully amortized loans with long terms up to 25 years and loan-to-value ratios up to 80%. Other banks may have interest-only loans with terms of 10 years and loan-to-value ratios of 65%. Generally, though, it’s harder to qualify for a traditional mortgage than other types of commercial real estate loans. Banks want to see borrowers with good personal credit, a strong business and a low debt service coverage ratio. Interest rates are usually within a few percentage points of a prime rate, such as the Wall Street Journal (WSJ) Prime Rate.
SBA 7(a) Loan
The Small Business Administration’s flagship loan, the 7(a) loan, can be used to purchase land or buildings, construct new property, or renovate existing property, provided the real estate will be owner-occupied. Through this program, you can borrow up to $5 million through an SBA-affiliated lender. The maximum allowed interest rates for the program are based on the WSJ Prime Rate plus a margin of a few percentage points. Interest rates can be fixed, variable or a combination of the two. Repayment terms for 7(a) loans used for real estate can go up to 25 years. These loans are fully amortized, meaning each monthly payment will be the same until the loan is paid off.
SBA 504 Loan
Beyond the 7(a) program, the SBA offers loans specifically for owner-occupied real estate or long-term equipment purchases. These loans, called 504 loans, are actually composed of two different loans: one from a Certified Development Company (CDC) for up to 40% of the loan amount and one from a bank for 50% or more of the loan amount. You, as a borrower, will be responsible for putting at least 10% as a down payment. The CDC portion of the loan can go up to $5 to $5.5 million, meaning the entire project being financed can be upwards of $10 million or more. You should aim to finance at least $350,000 through a 504 loan.
Interest rates on the CDC loans are based on U.S. Treasury rates and are fixed once you get the loan. Throughout 2017, these rates have fluctuated between 4% and 5%. The interest rates on the bank loan are typically variable. If you’re using the loan to purchase real estate, the maximum term is 20 years. Like the 7(a) loans, these loans are fully amortized.
Conduit loans are commercial mortgages that are pooled together and sold to investors on a secondary market. Because these loans are securitized, they behave a little differently than a traditional commercial real estate loan. The main differences relate to prepayment and loan administration as well as the flexibility you have in negotiating loan terms. The minimum amount that most conduit lenders will finance is between $1 million and $3 million. Most conduit loans have terms of five to 10 years with 20- to 30-year amortization periods. This means that each monthly payment will be the same until a final balloon payment at the end of the loan term. Interest rates on conduit loans are normally fixed and lower than rates on a traditional mortgage.
Commercial Bridge Loans
Like their name implies, bridge loans are used to "bridge the gap" until long-term financing can be secured for the commercial property. In some cases, the lender making the long-term loan will also make the bridge loan on the property. Most bridge loans come with very short terms, typically six months to two years, and many are not amortized (i.e., interest-only payments with a balloon payment at the end). Interest rates on bridge loans are a few percentage points higher than the going market rate.
How easy it is to qualify for a bridge loan will depend on the lender. Most lenders don’t take a one-size-fits-all approach, instead evaluating the unique situation at hand. Because of this, many borrowers will use a bridge loan to renovate a property that wouldn’t qualify for a traditional mortgage before selling it or getting long-term financing. Another advantage of bridge loans is the relatively low down payment requirement–generally between 10% and 20%. For comparison, many traditional commercial mortgages require a 20% to 35% down payment. Bridge loans also close more quickly than conventional real estate loans.
Soft and Hard Money Loans
Hard money loans are very similar to bridge loans, with the primary differences being that most hard money loans are made by private companies and there are higher down payment requirements. Like bridge loans, hard money loans have short terms, higher interest rates and interest-only payments. They are also easier to qualify for and faster to fund than a traditional mortgage. In many cases, they can fund faster than a bridge loan.
Soft money loans are a hybrid between a hard money loan and a traditional mortgage. Unlike hard money lenders, soft money lenders will place greater weight on your creditworthiness and the strength of your application. This means you’ll get a lower interest rate, lower down payment and longer terms than with a hard money loan. Like hard money loans, soft money loans are also quick to close. They can be a good option for borrowers who need to move quickly on a property but don’t want to pay the high rates that come with a hard money or bridge loan.