What You Need to Know About Securing a Commercial Real Estate Loan
So you’re an aspiring business owner looking to finance a brick and mortar location for your new business. Or maybe you’re currently a business owner who wants to renovate or expand an existing business.
But, securing a commercial real estate loan is a very different process than getting a mortgage loan for your primary residence. If you’re considering a commercial real estate loan for your business, here’s everything you need to know before you decide to apply for a commercial real estate loan.
How Do Commercial Real Estate Loans Work?
Commercial real estate loans are designed to enable businesses to purchase or renovate income-producing properties or refinance existing real estate debt on a property that you already own.
Although while commercial real estate loans have the same function as a traditional mortgage loan, there are some essential vital differences small business owners should understand before making that application for a commercial loan.
The loan-to-value ratio, LTV for short, is a metric that lenders use to determine how much money can borrow. More specifically, they calculate it by dividing the loan amount by the property’s value.
Homebuyers may qualify for a conventional mortgage loan with a Loan-To-Value (LTV) as high as 97%, and if you are eligible for a first-time homebuyer program or one of the select government-insured loans, you could get up to 100% financing.
With commercial real estate loans, however, lenders typically want an LTV of around 75% to 80%, according to the National Association of Realtors (NAR).
That being said, the NAR also found that a scant 60% of commercial real estate lenders used LTV as criteria for determining exactly how much a business can borrow. The remaining 40% used is what’s called the debt service coverage ratio, or DSCR for short.
The DSCR is used to measure the ability of a business to pay its current debt obligations with its current existing cash flow. To calculate it, you divide your annual net operating income by your total debt payments annually. According to the NAR, the median DSCR is 1.25.
TYPES OF COMMERCIAL REAL ESTATE LOANS
Commercial Real Estate Requirements
Each lender has their criteria for commercial real estate loans, but there are some essential questions to consider before you apply for those loans. For example, how much is a down payment on commercial property? And what are the financial business requirements?
To start, you can generally expect to put down a minimum of 20% most commercial real estate loans (the exception being SBA loans, which begin at 10%). Depending on the lender, the situation, and your own business’ financials, you may be required to put down much more.
Also, bear in mind that a higher down payment means a lower monthly payment going forward and lower interest costs for you, the borrower.
As for business financials, it depends on the lender. For example, SBA 504 Loans have a cap: your business’ tangible net worth cannot exceed $15 million, and average net income cannot exceed $5 million after taxes for the prior two years.
With commercial lenders, you may be required to meet absolute minimums, such as at least two years in business under the current ownership and $250,000 in annual revenue.
As you shop around and compare lenders, take note of their requirements to determine whether you qualify. Also, consider both traditional commercial lenders, mortgage brokerages and other online lenders in your search. While online lenders may typically charge higher interest rates, they can also have less stringent requirements for approval.