Key Takeaways
Commercial real estate loans are used to purchase, build, renovate, or refinance commercial real estate rather than residential. However, they may also be used to purchase and develop land on which to build and sell homes. With CRE loans, the borrower's credit and income are less important than with mortgages, with the income potential of the property being the primary driver.
Whether you're a developer embarking on a new subdivision project or an office building owner looking to refinance, you likely need a commercial real estate loan. Unlike residential real estate, commercial real estate refers to property used for business, such as hotels, office parks, and shopping centers. Typical borrowers of commercial real estate loans are business owners (including small business owners), developers, and investors. Commercial real estate loans differ from mortgages in terms of underwriting, structure, interest rates, and fees, and there are several types to choose from.
What is a CRE loan?
Commercial real estate loans (often abbreviated as CRE loans) are typically used to purchase, construct, renovate, or refinance commercial, industrial, or other non-owner occupied properties. This can include office buildings, multi-unit rental buildings, medical facilities, warehouses, hotels, or vacant land on which to build one or more of these types of properties. They can also be used to purchase and develop land on which to build and sell housing.
Unlike using a mortgage to buy a home, the asset covered by a commercial loan isn't your primary residence. A commercial lender will underwrite the loan based on the income the property generates (such as rent from tenants) and expenses.
“Ideal candidates for commercial real estate loans are borrowers who own property and are looking to lower interest rates by refinancing, or borrowers who are looking to obtain capital through a cash-out refinance,” says Chris Moreno, CEO of GoKapital in Miami. “Business owners who rent space and qualify for a commercial real estate loan may be better off taking out a loan to purchase commercial property.”
Types of Commercial Real Estate Loans
There are many different types of CRE loans, and here is an overview of the common commercial real estate loan types you can choose from.
Loan Type What You Need to Know Traditional commercial real estate loans Offered by banks, credit unions, and other lenders, with terms ranging from 5 to 30 years, interest rates as low as 3 percent, and minimum down payments of up to 20 percent. Commercial bridge loans Offered by a variety of banks and lenders as a way to bridge a financing gap until more long-term financing can be found. Terms are typically six months to three years, and only require a down payment of 10 to 20 percent. SBA 7(a) loans Offered by lenders partnered with the Small Business Administration (SBA). The loan agreement provides borrowers with $5 million for a term of up to 25 years, but only requires a down payment of 10 to 20 percent. SBA 504 loans Consists of a Certified Development Company (CDC) loan portion (up to 40 percent of the total amount borrowed) and a bank loan (up to 50 percent of the total amount borrowed). The maximum total balance is $5.5 million, the terms are 10 to 25 years, and the down payment requirement can be as low as 10 percent. CMBS or Conduit Loan Part of a pool of commercial real estate loans (commercial mortgage-backed securities, or CMBS) sold in the secondary market by conduit lenders and investment banks. The terms are usually 5 to 10 years, with a 30-year amortization period. A down payment of 25 to 30 percent is often required. Hard Money Loan Works like a bridge loan, but is usually offered by a private lender. USDA CRE Loan Designed to support the development and improvement of commercial real estate in rural areas, it is offered by approved lenders affiliated with the USDA. The terms are up to 30 years, and the minimum down payment is often 10 percent.
Commercial real estate loans are also categorized by asset class, which includes apartments, office space, medical facilities, industrial properties, as well as multi-unit and single-tenant assets.
“All of these things are valued differently by different lenders,” says Barry Saywitz, president of the Saywitz Company, a commercial real estate brokerage based in Newport Beach, Calif. “The value of the property is determined by the appraisal required, which is based on the quality of the tenant, credit, payment history, rent, condition of the building and associated costs.”
CRE loans for investment properties
Commercial real estate loans are a great way to finance many types of investment properties, but it's important to understand the rules.
“Investment properties have to be able to generate income, and loans are going to be evaluated on the caliber of the sponsor or owner,” says Rohit Mathur, CEO of Bridge, a commercial lender in New York City and Charlotte.
Like any other loan, lenders will broadly evaluate how trustworthy a loan on an investment property is that it will be repaid, said Adam Kenny, chief product officer at Boston-based commercial lending platform Numerated.
“What's unique about CRE loans is that the property is valued at the same value as, or in some cases even more than, the business holding the loan,” says Kenny. “The property's ability to reliably generate positive cash flow is almost always the largest factor in determining the ability to repay the loan.”
Commercial mortgage interest rates vary depending on the type of property and the income you expect to generate from it. Commercial mortgage lenders typically require a lower loan-to-value ratio, so commercial buyers may need to put a larger down payment forward than residential buyers. Like mortgages, commercial mortgage interest rates are affected by a variety of factors and adjust frequently based on market conditions.
Commercial and residential loans
Commercial Loans
The underwriting used for development and commercial real estate depends on the business's financial plan. Repayment periods are usually short.
Housing loan
Loans for personal residences are approved based on the borrower's personal financial situation. Repayment periods are generally long.
Like residential mortgages, commercial mortgages can be used to purchase or refinance real estate. However, commercial real estate loans typically have shorter terms than residential mortgages. A commercial loan might have a five-year fixed rate and a 15-year term, for example, and be amortized over 20 years, says James Sandagat, senior vice president at Cornerstone Bank in Southbridge, Massachusetts.
“The interest rate adjusts every five years, with the remaining balance due at the end of the 15-year term. This is called a balloon note,” Sandagat says. “You can either repay the remaining balance at the end of the term, or renew the loan at an interest rate and terms to be determined at that time.”
Commercial lenders also look to the property, rather than the borrower, as a source of debt repayment. “With a mortgage, the lender analyzes the borrower's income and creditworthiness to assess their ability to repay,” says Suzanne Hollander, a real estate lawyer and professor at Florida International University in Miami. “Commercial lenders look at the debt service ratio from the income the property generates.”
Riley Mahnke, a director at Walker & Dunlop in Calabasas, California, points out that while mortgages “are heavily dependent on the borrower's credit score and debt-to-income ratio, CRE underwriting depends on the borrower's net worth, liquidity and experience with the type of product they want to lend on.”
Additionally, the fees and closing costs for a commercial real estate loan are typically much higher than a mortgage, including a down payment, which may require at least 20 percent and up to 45 percent.
The appraisal process is also different, Saywitz said. Commercial appraisers consider a property's potential rental income, sales of similar properties and expected replacement costs, which typically takes longer than residential appraisals, which only look at sales of similar properties in the area.
And when it comes to interest rates, Moreno says you should be prepared to pay more if you get your commercial mortgage from a private lender. “If you want the deal to close quickly or your credit isn't great, you'll probably need to deal with a private lender,” he says.
How to Get a Commercial Real Estate Loan
The process of finding and applying for commercial real estate financing involves several important steps.
Carefully evaluate your commercial property finances. “Lenders will not only look at your personal credit history and financial situation, but they will also thoroughly evaluate your underlying assets,” says Moreno. Determine the type of commercial loan you need and compare. If your credit profile is solid and your financial situation is good, you should be able to work with a bank. “Typically, the primary avenue borrowers use is to seek out lenders in person, such as going to individual banks and asking about your options,” says Masser. Complete a commercial property loan application. You'll need to submit documents such as your personal and business tax returns, personal financial statements, personal balance sheets, and past income and expenses for the property.[This] “Loan approval can also include Schedule E of the property seller's federal tax return and/or a seller-prepared financial statement,” says Sandagato. Also, be prepared to provide a current list of each tenant, the space they occupy, the lease start date, lease details, and lease agreement. Wait for the loan to process and be underwritten. Lenders will use the information you provide to demonstrate the property's ability to repay debt. “Typically, lenders are looking for properties that can support a debt service ratio of 1.2 to 1,” says Sandagato. “That means that for every dollar of annual mortgage debt, there is $1.20 of cash flow to support it.” Close the loan. Commercial loans often take longer to close than residential mortgages. “Keep in mind that lenders view commercial property purchase loans as riskier than residential mortgages, so you'll need to do your due diligence,” says Hollander.
FAQ
Are CRE loans affected by rising interest rates and inflation?
The performance of almost all financial instruments, including commercial real estate loans, can be affected by economic conditions. Generally, when borrowing rates increase (whether due to inflation or other factors), commercial real estate loan interest rates also increase.
What is the term of a commercial real estate loan?
CRE loans typically have shorter repayment terms than mortgages, ranging from five to 15 years.
Can I get a CRE loan for a home?
CRE loans are specialized for commercial properties used for business purposes, such as office or retail space. For residential properties, borrowers must secure a mortgage. However, if a borrower plans to use the funds for a mixed-use property that has both commercial and residential uses, a commercial loan may be an option.