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How to finance commercial property

Lady holding a commercial property sign

Looking to invest in a commercial property in California? Potential investors and business owners who require financing to purchase an income-producing property must understand what it entails, how commercial real estate financing works, and what loan options are available.

Getting a commercial property loan

Commercial property loans are mortgages specifically meant for those wanting to generate income from real estate. Properties here are for business purposes, such as apartments for rent, retail stores and office spaces or warehousing and storage facilities, to name a few.

Taking out a loan of this nature usually requires the borrower to put up collateral to guarantee the mortgage. Failure to meet the commercial property loan’s repayment terms could result in the borrower’s property being foreclosed at most or blacklisting from making loans in the future at the least.

Note also that only business entities — not individuals — can take out commercial loans. So, if you’re breaking into the corporate world with your very own startup business, first have your business registered officially as a corporation or a limited liability company. Only then can you qualify for a commercial property loan.

Before approval for this particular type of loan, lenders will look into several factors:

  • How much the property is worth. A property appraisal ensures the lender that they will not be approving a loan that will not go higher than the property’s actual worth.
  • Down payment.The higher down payment for commercial properties (usually set between 30% and 45%) is justified due to the sizeable price tags that make the risks to lenders so much higher.
  • Credit standing. Lenders will want plenty of income and asset documentation to prove that you can make the mortgage payments.
  • Debt Service Coverage Ratio (DSCR).This is the amount the property can generate each month versus the amount due on your monthly mortgage. It helps lenders to determine how much you can reasonably pay on your commercial property loan each month.

Commercial real estate financing options

A loan does more than simply help in financing the property; this can also fund any additional construction projects related to your commercial property. Moreover, smart investors can leverage commercial property financing for the maintenance and operational requirements of their properties.

Where should an investor go to secure a commercial property loan? The most common practice is to secure a bank loan. However, you can also tap pension funds, insurance companies, and private lenders, as well as the U.S. Small Business Administration.

Those who want to buy a commercial property have the following commercial real estate financing options to consider:

  • U.S. Small Business Administration (SBA) 7A Loan. If you’re looking at a small commercial real estate investment project, this loan can be your best option. It guarantees repayment of a portion of the loan. SBA-backed loans help to reduce the risk for lenders so that they can become more inclined to charge some of the lowest interest rates. This is also the quickest and easiest to secure, making it the most popular option. The maximum amount of financing available through an SBA 7A loan is $5 million, with interest rates within the 7-10% range.
  • SBA 504 Loan. This particular loan is best suited for larger projects – those valued in excess of $1M. Also known as the Certified Development Company program, this type of loan requires the investor to put up a down payment amounting to 10% of the loan value. An SBA-Certified Development Company puts up 40%, while a conventional bank or another type of lender shoulders the remaining 50%. Because of the reduced risk to primary lenders, small businesses can easily qualify for a real estate loan.

Under an SBA 504 loan, lenders are charged an interest rate of 4% to 7%. This can also be used to buy, build or improve on owner-occupied commercial real estate or to purchase long-term business equipment.

  • Conventional bank loan. Nuances of this particular loan type are similar to traditional home mortgage loans. However, this requires a credit score of at least 660 and an average down payment of around 20% of the loan’s total value. Interest rates are competitive but the loan’s duration is usually shorter than that of a residential mortgage – between 5 and 20 years instead of 30. Moreover, the lender doesn’t require that the property be occupied by the owner.
  • Hard money loan. This short-term loan is also known as a bridge loan and terms for this range from one and three years. This loan enables borrowers to finance deals quickly. Longer-term bank loans with more favorable financing terms can then be negotiated with lenders. Approval of the loan is processed in as little as 10 to 15 days. A down payment of 15% to 35%of the purchase price may be required, but the loan has more chances of being approved.

Need help running through your checklist for buying commercial real estate? Let The R&Z Group of Marcus & Millichap help you out. Call us at 650.391.1758 and 650.391.1781 or get in touch with us by clicking here.

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