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, warehouse, etc. — 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 have three sets of requirements before granting a commercial loan to your small business. These requirements pertain to your business’s finances, your personal finances, and the property’s characteristics:

Business Finances

Typically, commercial real estate loans require more scrutiny than residential mortgages; 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.

The lender will also check your business’ 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 SBSS credit score is about 140 (the minimum for an SBA pre-screen), 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 limited liability entity: an LLC, LP, S, or C corporation. A real estate loan to a sole proprietorship would be considered personal rather than commercial, and would put your personal wealth at risk in the case of default.

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, like 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 are appropriate for rental properties.

Hard-money lenders typically base loans exclusively on property value with little reference to borrower creditworthiness. The property can be a commercial building, a storefront, a facility like a warehouse or lab, or other commercial property. Single family residences don’t qualify, although a multi-family property might if you run your business out of it and the business occupies at least 51% of the property.

Generally, a lender will let you borrow up to a maximum loan-to-value (LTV) ratio — typically around 65% to 75% — meaning that your company must put up the remainder as a commercial real estate loan down payment. 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 require much 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 meet these commercial real estate loan qualifications:

  • Up to five years of tax returns.
  • Your books, records and financial reports for up to the last five years or since inception, whichever is shorter. Will include off-balance-sheet financing, such as leases.
  • Projected cash flows for the life of the loan.
  • The credit reports of the business and all owners/partners.
  • Your state certification as a corporation or limited liability entity.
  • A third-party appraisal of the property.
  • A business plan that explains how the property will be used, as well as an explanation of the company’s management expertise and commitment.
  • For some programs, proof of citizenship.

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.

It can be harder for borrowers with poor credit or new businesses to access a commercial real estate loan, and even if available, finding one at a reasonable interest rate. A lender might need to reduce the maximum LTV it will offer, insist on credit score improvement, and/or demand additional collateral. Some steps you can take to overcome these obstacles include:

  • Applying for an SBA 504 or 7(a) loan if you meet the agency requirements.
  • Securing community grants if available.
  • Paying off existing debt and taking other steps to improve your credit score.
  • Adding a deep-pocket partner, investor or co-signer.
  • Pledging additional collateral if you have it.
  • Using a loan source that has fewer obstacles, such as a hard-money or peer-to-peer (P2P) lender.
  • 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 how to get a commercial building loan, there are multiple sources from which you can obtain one. 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 for each major source of commercial real estate loans:

Banks

Most banks provide commercial financing for various types of properties. Local banks tend to offer loans up to about $1 million, while regional and national banks can provide even larger loans. Generally, the property will need to be owner-occupied in order to qualify for commercial financing through a bank.

Pros:

  • Good rates.
  • Possible synergies with other accounts.
  • Long-term financing options.

Cons:

  • Requires the most documentation.
  • Slow process.
  • Only for borrowers with good or excellent credit.

Commercial Lenders

In addition to banks, there are countless non-bank finance companies that can provide commercial real estate loans for small- and medium-sized companies. Note that commercial loan rates 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 higher than 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 specifically for owner-occupied real estate or long-term equipment purchases. They are composed of two loans: one from a bank for 50% of the loan, and the other from a Certified Development Company for 40% of the loan. You must put at least 10% down.

Pros:

  • Below-market interest rates.
  • 10- and 20-year terms.
  • Low down payment.

Cons:

  • Only available after exhausting alternatives.
  • Public policy restrictions on eligibility.
  • Slow funding process.

SBA 7(a) loans

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

Pros:

  • Below-market interest rates.
  • 25-year term.
  • Most loans are fully amortized.

Cons:

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

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.
  • LTV often capped at 70% to 75%.
  • 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 between $1 million and $3 million with terms of five to 10 years.

Pros:

  • Low interest rates.
  • Amortization period longer than loan term.
  • Assumable loan if you sell the property.
  • Non-recourse loan doesn’t require personal guarantee.

Cons:

  • Balloon payment after 5- to 10-year term.
  • Based on credit score and property value.
  • 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.
  • Less regulations than traditional lenders.

Note that SBA-guaranteed loans require at least 51% owner occupancy for existing buildings and 60% owner occupancy for new construction. See this article for a summary of average commercial real estate loan rates.

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