Whether you are planning to develop, renovate or invest in commercial real estate, you’ll probably need to secure a commercial real estate loan. If it is your first time applying for this type of loan, it makes sense that you’ll want to learn more about how it works and what it involves.
In this article we discuss what commercial real estate loans can be used for, what lenders tend to look for when assessing an application, and the factors you should consider when choosing the product for your project.
What is commercial real estate lending?
Commercial real estate lending is a form of financing for commercial properties (offices, warehouses, retail units etc.) The loan is intended for businesses, developers and investors who will use the funds to build new properties or manage existing estates.
Equity currently held in existing property can also be used to provide funding for other purposes, whether it is to cover short-term cash flow needs or for business expansion.
How does commercial real estate lending work?
Although it is intended for commercial real estate, these loans work in a similar way to personal and secured loans.
Lenders will assess the:
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Borrowers’ creditworthiness
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Income potential of the property
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Overall risk of the loan
The loan is repaid over a fixed period, with added interest. If the borrower defaults on the loan, the real estate could be at risk of repossession.
What is commercial real estate lending used for?
The funds can be used in a variety of different ways, with some of the most common being:
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Offices: This can be for your own business to use as a workspace or as an investment opportunity to be leased out to other companies.
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Warehouses: Storage for holding stock or for businesses that need to operate in a larger space.
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Land for development: Loans are often taken out to purchase the land upon which commercial real estate will be built.
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Industrial: Factories and manufacturing plants can be a good long-term investment to cut down overheads.
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Mixed-use developments: Mixed used real estate lending focuses on combined commercial and residential spaces and can be tailored to individual projects.
What are the different types of commercial real estate lending?
Commercial real estate lending comes in many shapes and forms. Here are some examples of how it can be used:
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Commercial mortgages: These are repaid over a long period, typically between 20-30 years. They generally offer lower rates of interest, which makes them a good fit for land and property purchases. Commercial mortgages can be used to buy new property or to release equity for remortgaging.
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Development finance: For projects where renovation or construction is needed, development finance offers a medium-term funding solution. Eventually, the finance will be replaced by the sale of the development or via a mortgage-based solution.
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Bridging loans: This is a short-term lending option for businesses that need a quick injection of funds to tie them over until something more sustainable is actioned. Businesses can use the funds to capitalize on potential commercial opportunities rather than miss out due to lack of funding.
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Other types: Commercial real estate lending is also available in the form of equity finance, which involves the introduction of external investors. For more complex projects, structured finance is an option, while mezzanine finance is better suited for large construction and development projects.
What to consider with commercial real estate lending
Here are the main factors to consider when comparing the various products that are available on the market:
Loan to Value (LTV)
Lenders typically perceive there to be greater risk involved with commercial mortgages compared to residential mortgages. This means the LTV is usually different, so businesses are often asked to provide a larger deposit.
Interest rates and terms
In general, the longer the loan term is, the lower the interest rate will be. However, this will depend on your credit history and current rating. Market conditions also play a significant role, which can affect interest rates, especially over longer repayment terms.
Repayment structures
Some loans can be structured as interest only, which lowers monthly repayments. At the end of the term, the rest of the loan will need to be repaid in full. A repayment loan involves paying off the agreed monthly amount along with the interest. Exit strategy-based loans are short-term products and typically easier to secure provided an exit strategy is included in the business plan.
Lender requirements
When reviewing your application, lenders tend to focus heavily on risk, wanting to better understand the:
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Business plan – covering your business vision, ideals and financial forecasts
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Income potential of the property – relevant if you intend to lease out the property
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Creditworthiness of your business – analyzing your financial past, present and future
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Potential exit strategy – for short-term loans that require an exit strategy
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Structural warranty insurance – highlighting the measures taken to limit possible losses
Regulation
There are various tax regulations that will need to be considered. These taxes are based on the value of the property and local tax rate that will be applied. Capital gains tax becomes relevant if any profit is made when the property is sold, while state and federal income taxes are applied for commercial properties that earn rental income.
Final thoughts
Investing in commercial real estate can be a great way to expand your business assets. If you obtain a loan, it can be used for a wide range of commercial property activities, from buying an office or a plot of land to investing in a new warehouse or planning a new development. LTV, interest rates and repayment structures should all be considered when comparing products to ensure you get the best deal possible for your finances.
