Commercial real estate (CRE) is income-producing property used solely for business (rather than residential) purposes. Examples include retail malls, shopping centers, office buildings and complexes, and hotels. Financing—including the acquisition, development and construction of these properties—is typically accomplished through commercial real estate loans: mortgages secured by liens on the commercial property.
What Is a Commercial Real Estate Loan?
Just as with home mortgages, banks and independent lenders are actively involved in making loans on commercial real estate. Also, insurance companies, pension funds, private investors and other sources, including the U.S. Small Business Administration’s 504 Loan program, provide capital for commercial real estate.
Start by making sure your company’s finances are in order. “The most important requirement for getting financing is having a profitable and growing company,” Vincent says. “A business with no profitability doesn’t have good chances. Banks like to see a proven record of profits.”
Here are some valuable tips on how to improve your profitability.
Assess your space needs
Carefully study your real estate needs. Bankers don’t look kindly on financing requests for poorly thought-out, spur-of-the-moment projects. They want to see evidence of solid planning.
Figure out your budget, desired locations and square footage needs; whether you want to buy or lease; and how you’ll accommodate projected growth. “A lot of businesses don’t do proper planning before buying real estate,” Noël-Corriveau says. “For example, businesses often buy a space to meet only their current needs and forget about future expansion.”
When budgeting, it’s important to consider not just the purchase price (or, if leasing, the base rent), but also extra costs associated with the property. Businesses often overlook or underestimate extras such as due diligence costs, renovations, production downtime during the transition, legal fees, recurring operational expenses for the property and, in the case of a lease, incidentals and leasehold improvements.
Be sure you prepare an effective budget for your commercial real estate purchase or lease.
Have a property in mind
Banks decide how much to lend based not only on your finances, but also on the type of building, and its condition, age and resale potential. Without a specific property, it’s hard for a bank to be precise on how much financing it can offer.
You can also leave a poor impression if it looks like you’re not a serious buyer and are wasting the banker’s time.
If you don’t already have a property in mind, a bank may agree to a preliminary meeting to give you a ballpark idea of how much financing it could provide. However, such a meeting is generally advisable only if you already have a good relationship with the banker.
Prepare your documents
Once you have a property in mind, prepare the documents you’ll need to show the bank. These include up-to-date financial statements, a solid business plan and details on the property you’re interested in. Banks also like to see evidence of an experienced management team.
“It’s like getting ready for a job interview,” Vincent says. “You should plan to make a good first impression, be on time for the meeting and be well prepared.”
Evaluate your commercial loan requirements.
After you think you’ve determined the type of commercial loan that’s right for your financing needs, you might be wondering: How do you qualify for a commercial loan?
Ultimately, the qualifications that you’ll need to meet will largely vary based on the type of loan and the lender.
This being said, however, before you take the time to evaluate every single option, and put together an application for many different types of business loans, it’s important to get a sense of what you might qualify for based on the details of your business.
Doing so can save you time and effort spent applying to commercial loans that don’t fall within your qualifications.
With this in mind, let’s break down the three most common commercial loan requirements that lenders will use to evaluate your business.
Meet the bank before bidding
It’s best to meet your banker before bidding on the property you have in mind, especially if it’s your first foray into commercial real estate.
The bank will also advise you on its conditions for granting financing. Those may include obtaining environmental and building condition assessments, an appraisal, and a title search. It helps to use approved experts for this kind of due diligence, and each bank has its own list of such experts. If you use someone else, the bank may require a second opinion and the transaction could be delayed.
Give yourself time
Your purchase offer should also give the bank enough time to review the transaction. It’s common for offers to provide only 30 days, while banks often need six weeks—and possibly more, if due diligence issues arise.
“Businesses usually don’t give enough time for the bank’s due diligence,” says Vincent. “Then, the buyer and vendor can end up arguing about extensions to the offer, and the transaction can even be cancelled.”
Investigate loan terms, not just rates
When speaking with banks, look not only at their rates, but also their terms. These can sometimes be just as important to your bottom line.
- A key variable is the loan-to-value ratio— the portion of the property’s value that the bank will finance. Banks generally offer to finance 75% to 100% of the value of commercial real estate, depending on the building’s condition, resale potential and other factors. Any shortfall must usually come from the company’s working capital or the entrepreneur’s personal funds. A higher ratio means more money remains in your company in the near term to invest in growth or to cover cash flow shortages.
- A second variable is the amortization period. For a commercial real estate term loan, this usually ranges from 15 to 25 years. You may want a longer period in order to keep more money in your hands now.
- Third, consider the bank’s flexibility in offering loan repayment holidays. For example, you may be able to seek a holiday on capital repayments for one or two years post-transaction in order to absorb the cost and disruption of the move. Or, if you experience a cash crunch later, flexible terms could allow you to postpone repayments until you’re back on your feet.
- The bank may also be able to roll some or all of the cost of renovations into the term loan, particularly if they add value to the property. Be sure to thoroughly explore your bank’s various financing options—you may be pleasantly surprised at the opportunities they open up for your business.
Close your loan.
At this point, we’ve reached the last step of our process explaining how to get a commercial loan.
After you’ve gathered the necessary documents and submitted your application, you’ll be waiting on a decision from the lender. Generally, alternative lenders can issue an initial approval within a few days, depending on the product, whereas bank and SBA loans will require much longer timelines.
This being said, once you (hopefully) receive approval for a lender, or multiple lenders, you’ll want to take the time to evaluate and compare offers. Ultimately, the best commercial loan for your business will not only be the one that meets your needs, but also the one that’s most affordable.
Once you’ve decided on the offer you’d like to move forward with, you’ll work with the lender to close your loan. During the closing process, you’ll want to make sure you review the business loan agreement thoroughly, ask any questions you may have, and perhaps even review the document with a financial advisor or business attorney.
Finally, after you’ve signed all the necessary documents and completed the closing process, you’ve successfully obtained a commercial loan. Therefore, all that’s left to do is wait for the funds to hit your bank account. Again, the timeline for this process will vary based on the lender and the product you’ve chosen.
Advantages of a Commercial Loan
1. Access to capital
A commercial loan provides additional cash for a business. The cash may be used to purchase new equipment, satisfy payroll expenses, etc.
2. Easier application process
Although the application process for a commercial loan may seem daunting, it is easier than raising money in the equity or debt markets. There are regulatory hurdles and significant costs and time required to raise money through equity and/or bond markets.
3. Retaining ownership
A commercial loan does not dilute the business owner’s equity. For example, a business may issue equity to raise money. In doing so, the owner would be diluting their own equity in the business. As such, a commercial loan allows an owner to raise money without diluting their stake in the business.
Disadvantages of a Commercial Loan
1. Paperwork and application process
A commercial loan requires a significant amount of paperwork and involves a tedious application process. For example, a business may be required to submit an outline of its business plan and give a presentation outlining its business goals and objectives.
2. Inflexibility in the use of funds
When applying for a commercial loan, the business must specify what the money will be used for and how it will pay back the loan. This results in inflexibility of the funds, as the business is required to commit to its original plan(s).
3. Interest costs
A commercial loan comes with a stated interest rate, which may be floating or fixed. As such, the business is required to make monthly payments on the money it borrows.
Want to learn more about commercial loans and find out what it takes to become a world-class Commercial Loan Broker or Commercial Loan Officer? Use the form below to learn more about CFI’s Commercial Banking & Credit Analyst certification.