Loans for commercial real estate come in all shapes and sizes. In this guide, we will review how commercial loans work, what lenders look for, and how to get a commercial loan for a rental property.
1. What is a Commercial Real Estate Loan?
A commercial loan, also called a commercial mortgage, is used to purchase or renovate a commercial or income property. Examples of commercial real estate include apartment complexes, office buildings, retail spaces, and warehouses. Residential real estate can also be financed under a commercial loan if it is purchased as an investment property. Here, we will cover the main differences between commercial loans and residential loans.
Commercial Loans vs Residential Loans
| Commercial Loans | Residential Loans |
|---|---|
| Issued to businesses (e.g. LLC) | Issued to an individual |
| Shorter loan term repaid in installments and a lump sum | Longer loan term repaid in regular installments |
| Low loan-to-value ratios between 65% to 80% | High loan-to-value ratios up to 100% |
| Time to Close: 5-30 days | Time to Close: 45-60 days |
Individual vs. Business
Residential loans are issued based on the financial status and credit history of an individual. The application process is similar to getting a mortgage on a primary residence. The bank will want all of the same documents, including pay stubs, tax returns, financial statements, in addition to collateral offered to secure the loan.
Commercial loans are issued to business entities such as corporations, developers, partnerships, funds, trusts, and real estate investment trusts (REITs). The loan is secured based on the rental property being purchased and the credit history of either the business or the owners of the entity.
Loan Repayment Schedules
Residential loans are typically amortized over 30 years with fixed monthly installments until the loan is repaid in full at the end of the term. While each type of commercial loan is structured differently, the loan term is often shorter than the amortization period. Terms range from 5 to 20 years, followed by a “balloon payment” of the remaining balance on the loan.
Loan-to-Value Ratios
Lenders will use a loan-to-value (LTV) ratio to determine the interest rate of a loan for commercial real estate property. The LTV is calculated by dividing the mortgage amount by the lessor of the property’s selling price or appraised value. For example, the LTV for a $100,000 loan on a $125,000 property would be 80% ($100,000 / $125,000 = 0.8).
A lower LTV ratio usually results in more favorable loan terms and interest rates. Some residential loans can still be issued with high LTVs between 95% to 100%, including VA and USDA loans, FHA loans, and conventional loans. Generally, commercial loans come with an LTV of around 65% to 80%.
The incentive for lenders to issue loans for commercial properties is because they typically attract wealthy tenants and can produce millions of dollars in revenue. Although the risk is higher than commercial loans for residential real estate, the financial gains can be even higher.
2. What are the Types of Commercial Real Estate Loans?
Commercial loans aren’t one-size-fits-all. The various types of real estate investments require different loans, each with its own terms, rates, and uses. We take a closer look at some of the options for commercial loans below.
Small Business Administration (SBA) Loans
The United States Small Business Administration (SBA) offers two programs for financial institutions to guarantee most or all the funds for commercial loans. This guarantee acts as a type of insurance for the lender. If you default on your loan, the government pays the lender back the guaranteed amount. The downside to SBA loans is they are difficult to qualify for and often come with high fees.
SBA 7(a) Loans: This is the most common program for commercial loans that can be used to purchase, renovate, or buy equipment for a rental property. The maximum loan amount is $5 million based on your business income, credit history, and location.
SBA 504 Loans: This loan program offers fixed-rate financing up to $5 million for fixed assets, including existing buildings or land. Eligibility is based on your business net worth, net income, and where you operate.
Permanent Loans
Permanent loans offer long-term financing for commercial real estate. They tend to come with lower interest rates and are typically amortized over 25 years. This type of financing starts as a construction loan and then transitions to a permanent loan once the construction is complete, so you only pay closing costs once. These loans offer flexible repayment schedules, including monthly, annual, or lump-sum payments. One of the most challenging aspects of these loans is the potential for delays in construction that will stall the transition to a permanent loan.
Blanket Loans
If you plan on buying several investment properties, a blanket loan can help simplify the lending process. This type of commercial financing offers one loan, one interest payment, and one set of terms for multiple properties. Blanket loans also help with cash flow because you’re only paying for one loan rather than separate fees for each property. Additionally, a release clause will trigger if one rental property is sold or refinanced while keeping the other properties under the “blanket”. However, keep in mind that blanket loans tend to be big because they cover multiple properties. This results in larger payments that increase the chance of defaulting on the loan.
3. What are the Advantages of Commercial Real Estate Loans?
While there are plenty of ways to purchase investment property, commercial loans typically offer more flexibility for real estate investors and landlords. For instance, compared to residential loans that can only be secured through traditional financial institutions, commercial loans can be issued by private companies or individuals. Below are some of the main benefits of commercial loans:
Loan Terms: Instead of spreading payments over 30 years, commercial loans typically last between 10-20 years. A commercial bridge loan can be as short as six months to a few years. Terms can usually be negotiated with the lender.
Finance Options: One of the biggest upsides of commercial loans is the option to skip the traditional lender route. Hard money commercial loans come exclusively from private investors willing to take a lending risk based on property value instead of a credit rating.
Cash Flow: Commercial properties with over four units have more cash flow opportunities. Typically, these investments have a higher return on investment (between 6% to 12%) compared to properties financed under residential loans.
For many, the flexibility of commercial financing makes them the loan of choice for investors — even if they could technically use a residential loan.
4. How to Get a Commercial Loan for a Rental Property
To get a commercial loan for a rental property, you will first need to decide on the type of loan you need. The next step is to compare rates from different lenders to determine which one works best for you.
Banks: Traditional banking institutions tend to provide competitive rates for financing real estate properties.
Commercial Lenders: Non-bank finance companies provide commercial loans for small and medium-sized companies.
Private Investors: Commercial loans from private investors are easier to qualify for and get approved faster than a bank loan.
You can use a a private money loan originator or a mortgage broker to find a lender with the best rates. If you are going with a broker, be prepared to pay a finder’s fee if you choose this route. Also, commercial loans usually involve fees that add to the overall cost of the loan. For example, a loan may require a one-time origination fee of 1% due upon closing, and an annual origination fee of 0.25% until the loan is paid in full.
5. How to Qualify for a Commercial Real Estate Loan
The application process for a commercial loan will vary based on the type of loan and lender you choose. In general, lenders will assess the following information:
- Debt service coverage ratio
- Credit history
- Financial reports
- Property appraisal
- Collateral assets
In most cases, buildings with 51% occupancy by the property owner’s company (also known as owner-occupied) will qualify for commercial loans faster. Banks consider this a sign that the business is more invested in the property.
The Bottom Line: Finding the Right Commercial Loan
Finding the best commercial loan for your real estate investment will depend on the amount of money you want to spend, the time you’re willing to commit, and how much risk you’re comfortable with. When you start talking to lenders, it’s always a good idea to shop around to compare rates and terms.
FAQs
In theory, there's no limit to how many commercial real estate loans you can get. However, qualifying for multiple loans isn't always easy and will depend on the lender you turn to.
The FNMA Program allows qualified investors to finance up to 10 real estate properties. Commercial loans may be good options for investors looking to buy more than 10 properties.
When purchasing real estate, investors have two main property loans to choose from: commercial and residential. Residential loans (also called consumer mortgage loans) are used for single-family homes and residences with less than four units.
Commercial loans are used for rental properties with five or more units like offices or warehouses or real estate companies (e.g. LLC). You can buy up to 10 investment properties with a residential loan, but most lenders will only underwrite up to five properties before recommending a commercial loan.
The IRS business loan interest deduction lets you write off the interest paid on a commercial loan. For example, if you paid $2,000 in interest every month, you can claim $24,000 as a tax deduction.
Some commercial real estate investors may also be eligible for the qualified business income (QBI) deduction under Section 199A of the Tax Cuts and Jobs Act. This section allows for a 20% tax deduction of qualifying income, plus 20% of qualified real estate investment trust (REIT) dividends.
