How to Get a Commercial Real Estate Loan: What Do Lenders Consider?

How to Get a Commercial Real Estate Loan: What Do Lenders Consider?

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Purchasing commercial property to either set up a new facility (a store, office or warehouse, for example) or to expand an existing one is often a major commitment for a small business, one that is usually financed by a commercial real estate loan. Your business’s access to this kind of loan — which in some respects resembles a residential mortgage for business property — depends on several factors that vary according to the loan source. The Small Business Administration (SBA) has programs that guarantee commercial real estate loans.

How to get a commercial real estate loan

Commercial real estate loans are generally used to purchase or renovate commercial property. Lenders usually require that the property be owner-occupied, meaning that your business will have to occupy at least 51% of the building. To get a commercial real estate loan, you’ll need to decide on the type of commercial loan you need — depending on the property and business — and then narrow down your lender options.

What do lenders look for?

Lenders typically have three sets of requirements before granting a commercial loan to your small business. These requirements likely pertain to your business’s finances, your personal finances and the property’s characteristics.

Business finances

Typically, commercial real estate loans require a lot of scrutiny — small businesses are considered risky, and many don’t end up succeeding. Banks and commercial lenders will need to look over your books to verify that your business has the cash flow necessary to repay the loan.

A lender is likely to calculate your company’s debt service coverage ratio, which is defined as your annual net operating income (NOI) divided by your annual total debt service (the amount you’ll have to spend paying back principal and interest on your debt). A ratio of 1.25 or greater is a typical requirement. For example, if your business is debt-free and applies for a $100,000 commercial real estate loan, the lender will want to see that you generate a NOI of at least $125,000.

Business credit

The lender will also check your business’s credit score to gauge your access to a commercial loan and the terms — interest rate, payback period, down payment requirement — that will apply. The minimum required FICO Small Business Scoring Service (SBSS) credit score is 155 for the SBA 7(a) loan, the government agency’s flagship loan program, although there are plenty of exceptions that allow small businesses to get a loan with a score lower than the minimum.

Your small business should be structured as a business entity, like a limited liability company or an S corporation. A real estate loan to a sole proprietorship would be considered personal rather than commercial, which would put your personal wealth at risk if you default on the loan.

Personal finances

Small companies are usually controlled by an owner or a few partners. Banks and commercial lenders will want to check your personal credit score and history to see if you’ve had financial problems in the past, such as defaults, foreclosures, tax liens, court judgments and more. A low personal credit score could harm your company's chance of approval for a commercial loan.

Property characteristics

The property being financed by the loan acts as collateral, and the lender attaches a lien to the property that allows seizure if you fail to repay on time. To qualify for a commercial real estate loan, your small business will usually be required to occupy at least 51% of the building. Otherwise, you should be applying for an investment property loan instead, which is appropriate for rental properties.

Hard-money loans

Hard-money lenders typically base loans exclusively on property value with little reference to borrower creditworthiness. Eligible properties can include commercial buildings, storefronts or facilities like a warehouse or lab. Single family residences won’t qualify, though a multi-family property might if you run your business out of it and the business occupies at least 51% of the property.

Generally, commercial real estate loans come with a loan-to-value ratio (LTV) of around 65% to 80%. For example, if the property is appraised at $200,000 and the lender requires a 70% LTV, you’ll be expected to put down $60,000 to receive a loan of $140,000.

How to prepare for the application process

Applying for a commercial mortgage can be slow and often requires a lot of documentation. At the other extreme, you might be able to secure a hard-money loan in days without producing copious financial information.

In general, banks and lenders will require you to provide this common information:

  • Business tax returns
  • Your books, records and financial reports
  • Last three months or more of bank statements
  • Details regarding collateral
  • Third-party appraisal of the property
  • Business plan

On the other hand, a hard-money lender will concentrate on the current and projected value of the property, with fewer requirements for other financial disclosures.

How to improve your chances of getting approved

Business owners with poor credit or new businesses may face more obstacles when applying for a commercial real estate loan. Some things you can do to help boost your chances of getting improved include:

  • Paying off existing debt and taking other steps to improve your credit scores
  • Pledging additional collateral if you have it
  • Adding an investor or cosigner
  • Agreeing to pay a larger down payment and/or higher interest rate
  • Selecting a less expensive property

Where to get a commercial real estate loan

If you're wondering where to get a commercial building loan, there are multiple sources you can obtain one from. You'll have to compare commercial loan rates from various lenders to find out which one works best for you.

The following is a summary of the pros and cons of working with certain types of lenders:

Banks

Most banks provide commercial financing for various types of properties. The typical loan size for a traditional bank loan is about $1 million.

Pros:

  • Good rates
  • Convenience, possible discounts as an existing bank customer
  • Long-term financing options

Cons:

  • Requires extensive documentation
  • Slow process
  • Only for borrowers with good or excellent credit

Commercial lenders

In addition to banks, there are many non-bank finance companies that can provide commercial real estate loans for small- and medium-sized companies. Note that rates for commercial loans tend to be higher compared to banks; however, if you need a loan fast, this could be a good option.

Pros:

  • Less rigid underwriting standards
  • Faster approval than banks
  • Lower fees and closing costs

Cons:

  • Interest rates are often higher than with banks
  • May require a balloon payment in 5 to 10 years
  • Many are short-term loans

SBA 504 loans

These loans were designed by the SBA and can be used for real estate or long-term equipment purchases. They are composed of two loans: one from a bank that’s typically 50% of the loan, and the other from a Certified Development Company for up to 40% of the loan. You must put at least 10% down.

Pros:

  • Below-market interest rates
  • Terms of 20 or 25 years
  • Low down payment

Cons:

SBA 7(a) loans

Using the SBA's flagship loan, you can borrow up to $5 million through an affiliated lender, depending on eligibility. These loans can be used to construct new property, renovate property and purchase land or buildings. Rates are based on the prime rate plus a margin of a few percentage points.

Pros:

  • Competitive interest rates
  • Terms of up to 25 years
  • Most loans are fully amortized

Cons:

  • Limits on company size
  • Requires satisfactory credit score
  • Lengthy approval time

Note that SBA-guaranteed loans require at least 51% owner occupancy for existing buildings and 60% owner occupancy for new construction.

Hard-money lenders

Hard money loans are short-term loans based on the value of the property. These loans are usually made by private companies and tend to have higher down payment requirements. Qualifying for the loan is easier and getting the loan tends to be faster than a traditional mortgage.

Pros:

  • Doesn’t evaluate borrower’s credit rating
  • Fast approval
  • Easier to qualify for

Cons:

  • Higher interest rates
  • Average LTV ratio is 60% to 80%
  • Short-term financing

Conduit lenders

Conduit loans are commercial mortgages that are pooled together with other types of commercial loans and then sold to investors on a secondary market. Conduit lenders will usually finance a minimum of $1 million to $3 million, going up to $50 million, with terms of five to 10 years. Amortization is typically spread out for a longer period, which keeps payments relatively low, but you’ll pay the balance in one final, large balloon payment.

Pros:

  • Low interest rates
  • Amortization period longer than loan term
  • Non-recourse loan doesn’t require personal guarantee

Cons:

  • Balloon payment after 5- to 10-year term
  • Significant prepayment penalties

P2P marketplaces

Crowdlending platforms match borrowers to individual lenders. There are multiple marketplaces focused on commercial lending. These services are a good option for short-term bridge loans, which are used to "bridge the gap" until long-term financing is secured.

Pros:

  • Fast turnaround
  • Loan access for most credit scores
  • Easy application process

Cons:

  • May have high interest rates
  • High origination fees
  • Fewer regulations than traditional lenders