Introduction- What is a Commercial Real Estate Loan?
A commercial real estate loan is a loan or mortgage loan secured by a lien on an income-producing property or one used for business purposes. This can be a multifamily building (apartment building) with over 4 units, office, retail or industrial properties. Today most commercial loans are financed by banks or government programs like SBA, Freddie, Fannie, HUD, insurance companies, and the like. Commercial real estate loans can also be financed utilizing private equity in conjunction with conventional sources to achieve higher leverage or loan to value. A great place to achieve your specific real estate loan is a commercial lender like CambridgeCapital.org.
“Commercial Real Estate Loan: 100% Financing”
When one thinks about a commercial mortgage it is in one of two ways. The first being a business purchasing a property to run their business in and the second would be a professional real estate investor purchasing a commercial or investment property for their investment portfolio. From a residential lending standpoint a commercial property is a property of over 4 units and from a banking perspective, it is a property utilized for business purposes vs occupying as a place to live.
How Commercial Real Estate Works?
Even though there are similarities between a traditional mortgage and a commercial real estate loan, there are key contrasts within both of those aspects. We discuss them below:
1. Loan-to-Value ratio
LTV (Loan-to-Value) Ratio is a quantity that the lenders use to find out the amount of the purchase price that they are willing to loan on the property. Its calculation is done by dividing the loan amount by the property value. For most commercial mortgages today you can achieve 75% LTV. If you are going for a government-insured loan, there is a possibility of achieving financing 80-90 %.
If we talk about structured financing there it is possible in the right circumstances to get you to 100%.
According to NAR (National Association of Realtors), only 58% of the commercial real estate loans were used to determine the amount of money that a business can borrow. The remaining 42% of the amount is associated with the DSCR (Debt Service Coverage Ratio). DSCR ensures if the borrower can meet the demands of his debt obligations with his current cash flow or financial balance. For its calculation, you must divide your annual income with the debt payments for the year. According to the current report, the DSCR is averaged to be 1.25.
2. Personal Guarantee vs Non-Recourse Loans
Regardless of your choice regarding a mortgage or a commercial real estate loan, your lender will use your property as collateral to pay the current debt.
There are many aspects to the personal guarantee and a few that you should be aware of prior to signing your loan documents.
If you are in the investment real estate business and purchasing an investment property than your property is typically in an LLC. An LLC is a Limited Liability Company. It can be setup to purchase one property or many. Your property will be purchased by the LLC so that the company is first and foremost responsible for the loan in the event of a default.
This offers the investor multiple protections against lawsuits. However, most lenders require a personal signature on any type of loan today. This means that if the LLC cannot pay back the loan the lender has the right to go after the individual for the balance owed. For small investment loans this is very common. For larger cash flowing properties like a multifamily apartment building you may have the option of not entirely guaranteeing the loan but signing what is known as “a good guy clause”. This is a clause that only makes a principal responsible in the event of fraud or for other specific reasons. Outside of fraud if the LLC or corporation cannot pay back the loan a good guy clause typically allows the principal to just hand over the keys to the bank and walk away without any liability.
Non Recourse – Loans -Loans where the LLC or company under which a property is purchased is fully responsible for the repayment of a loan. Most property types today require some form of guarantee. Even a CMBS or Life loan requires some form of good guy clause, however limited the recourse might be, you want to carefully review what your liability is with any type of loan or mortgage you are walking into.
Pros and Cons of Commercial Loans
Advantages
- Commercial real estate loans provide lower rates than many other types of financing. These are typically fixed rates that allow for easy budgeting.
- Depreciation
- Appreciation
- Tax Advantages
Disadvantages
- Commercial real estate loans are very time-consuming and take time to get approved.
- You will need a good credit score for its approval.
- Larger deposits are required for a commercial mortgage
- Property maintenance will become your responsibility and you should be sure that it is worked into your budget.
Conclusion
Commercial Loans are fundamental in the expansion of a small business. They provide the business with a platform to build on their original business. As we have so many financial calculations to do in the modern world, we must be cautious in terms of the lender and the loan type that we are selecting.
Furthermore, you should also consider the right repayment term. If you have a loan with a balloon payment, it will provide lower payments. However, it may give you problems if you cannot meet your household debts in the future.
In the end, it is important to draw a comparison between every loan on full terms instead of just the repayment terms. You must know if there is any penalty if you pay the loan early, or if your lender needs specific permission.
