Commercial Real Estate Financing
Things You Need To Know About Commercial Real Estate Financing
If you’re looking for information on commercial real estate financing, the below guide will help you understand the basics and how you need to apply for commercial real estate financing. First and foremost, it is important for you to understand that there is huge difference between arranging financing for residential real estate and commercial real estate.
Residential Real estate and Commercial Real Estate Financing
When it comes to arranging financing for a residential real estate deal, the lenders are not looking at the money that is likely to be generated from the residential property. They are more concerned with the actual value of the property as well as the paying capacity of the borrower.
It is also a given that residential property usually appreciates in value over time.
However, the commercial real estate is a completely different ball game. When you go to a lender for commercial real estate financing they will look at your business plan and how you plan to generate profits through that commercial property. In other words, their decision will be based on the money that is likely to be generated from that commercial property and whether the business plan prepared by you is realistic enough to allow you to pay back the loan with interest.
How Commercial Real Estate Loans differ from Residential Mortgages?
One of the biggest differences between residential mortgages and commercial real estate loans is that the loans for commercial properties are made to business entities that can be a partnership, a trust, a corporation or other such entities. In many cases, entities are formed for the specific purpose of making money through investment in commercial real estate. In most cases, a commercial entity is not likely to have any credit history or a financial track record and in such cases, the owners of the business entity are required to guarantee the loan.
Therefore, lenders base this decision on the financial track record or credit history of the owners of the entity, and since they have guaranteed the loan, they can be pursued to recover the loan in case of default. In some cases, non-recourse loan is also given by lenders which means there is no personal guarantee given by the owners and the only means of recovering the loan is through the property.
Commercial Loan Repayment Schedule
As far as the loan repayment schedule for commercial property is concerned, it is much different from the loan repayment schedules for residential mortgage. In case of a residential mortgage, the borrower is required to repay the debt in regular instalments over several years. In most cases, lenders give a 30 year fixed rate mortgage which means the borrower is required to pay back the loan over a 30 year period by way of monthly instalments. Several other options such as 15 year or 25 year mortgages are also available to the residential borrowers.
On the other hand, the conditions for commercial loans are completely different. In many cases, the loan is typically given for less than five years to 20 years. However, the loan is not amortized completely over the term of the loan. For instance, a loan may be given by the lender for a period of 5 years but the amortization period may extend to 25 years. In such cases, the borrowers are required to make payments for a period of 5 years which is then followed by one final payment that covers the entire outstanding loan balance.
Loan to Value Ratio
Another difference between residential loans and commercial loans is the loan to value ratio. In simple terms, the loan to value ratio may be defined as the amount of the loan as compared to the value of the underlying real estate. Residential borrowers are usually allowed high loan to value ratio which means they are eligible for a high percentage of the loan as compared to value of the property. In many cases, a residential borrower can expect financing of up to 95% of the total value of the property. On the other hand, the loan to value ratio in case of commercial loans is much lower. In most cases, it ranges between 65 to 80% though there are exceptions.
How To Apply For Commercial Real Estate Financing?
As far as applying for commercial real estate financing is concerned, you need to be prepared with a clear business plan in order to get approved for a loan. Your business plan should include how you plan to use the property and what kind of business you are planning to run on this property. In other words, you need to convince the lender that you will be able to repay the loan through the money generated from your business on that commercial property. Another factor that affects the probability of approval is location of the property. You are less likely to get a loan for a place that is located far away from the city as compared to a place that is located in the city where you are likely to get more business.
Overall, it is important for you to keep in mind that getting financing for a commercial real estate project is a long process and you need to be prepared with a foolproof business plan in order to get approved for a commercial real estate loan.