Benefits of Investing in Small-Balance Commercial Real Estate Loans

Commercial real estate (CRE) investments come in many shapes and sizes, and one area gaining attention is small-balance commercial real estate loans. These loans, typically ranging between $100,000 and $5 million, are often used to finance smaller commercial properties like office buildings, retail spaces, warehouses, and multifamily properties. For investors, small-balance CRE loans can offer unique opportunities with lower barriers to entry, higher flexibility, and diversified returns.

In this article, we’ll explore the benefits of investing in small-balance commercial real estate loans and why they might be the right fit for your portfolio.

1. Lower Barriers to Entry

Investing in commercial real estate traditionally requires significant capital, but small-balance CRE loans open the door for more investors by lowering the financial requirements. With lower loan amounts, investors can enter the commercial real estate market without needing millions in initial capital. This makes it an attractive option for newer investors or those looking to diversify without overextending themselves.

Example: A first-time commercial real estate investor in Jackson, MS, secures a $250,000 loan to purchase a small retail building. By entering the market with a smaller property, the investor doesn’t need to come up with millions of dollars in upfront capital, allowing them to build experience and earn rental income without the high financial commitment.

2. Diversification of Investment Portfolio

Small-balance loans allow investors to spread their capital across multiple properties or borrowers, reducing the overall risk. Instead of committing all resources to one large property, investors can finance several smaller projects. Diversification across different types of commercial properties—such as retail, office space, and industrial—helps mitigate risks associated with any one sector’s downturn.

Example: Instead of investing $1 million in a single high-rise office building, an investor spreads the same amount across five small-balance loans, financing a mix of retail shops, office spaces, and small industrial warehouses. This diversification protects them from the impact of downturns in any one real estate sector or location, stabilizing their portfolio's overall return.

3. Higher Returns Compared to Residential Investments

Small-balance CRE loans often offer higher interest rates compared to residential real estate loans, potentially yielding higher returns for investors. Because of the additional risk involved in commercial real estate, lenders typically charge higher rates, allowing investors to earn more from their loan portfolios.

Example: An investor who previously invested in residential rental properties earning 4-5% return shifts to small-balance commercial real estate loans, which provide a return of 7-9%. By accepting a slightly higher risk, they earn significantly higher profits while still maintaining manageable exposure.

4. Flexible Terms and Structures

Another advantage is the flexibility these loans provide. Investors can negotiate terms that fit their financial strategies, such as short-term loans for quick turnovers or longer-term loans for consistent cash flow. These flexible loan structures allow investors to tailor their investments to their specific goals, whether they’re looking for quick profits or long-term income generation.

Example: A developer plans to complete renovations on a small office building in one year and sells it for a profit. They negotiate a short-term, interest-only small-balance loan, which allows them to lower monthly payments while they focus on adding value to the property. The flexibility of this loan structure matches their goal of a quick turnaround.

5. Favorable Risk-Reward Ratio

While small-balance commercial loans carry risk like any other investment, they tend to have a favorable risk-reward ratio. These loans are typically secured by income-producing properties, and because the loan amounts are smaller, there’s less exposure to large-scale losses. Additionally, many small-balance borrowers are seasoned entrepreneurs with reliable business plans, which further mitigates risk.

Example: A small-balance loan finances a $500,000 neighborhood retail center with stable long-term tenants. Although the loan size is relatively small, the property generates consistent cash flow from tenant rents, making the risk low relative to the steady income it produces. The investor benefits from steady returns without the risks associated with larger developments.

6. Growing Demand for Small-Balance Loans

With the rise of small and medium-sized businesses and the demand for flexible workspaces and retail spots, the need for financing smaller commercial properties is growing. Investors in small-balance CRE loans can capitalize on this expanding market segment, enjoying steady demand for their capital.

Example: A property owner seeks financing to convert a small warehouse into shared office spaces for freelancers and small businesses. Due to increasing demand for flexible workspaces in the area, the loan is quickly approved, and the investor benefits from strong rental demand. The rise in small business growth creates more opportunities for loans in this sector.

7. Opportunity in Secondary Markets

Small-balance loans are often tied to properties in secondary or tertiary markets where large institutional investors may not focus. These markets can offer strong growth potential, particularly as urban areas become saturated. Investors can gain a foothold in up-and-coming areas with smaller commercial properties that are ripe for development.

Example: An investor purchases a small mixed-use building in a growing town outside of Memphis, TN, where property values are steadily rising. Larger institutional investors have overlooked the area, but by purchasing the property at a lower cost, the investor benefits from significant appreciation as the town expands, demonstrating the potential of secondary markets.

8. Access to Non-Traditional Borrowers

Many small-balance CRE loans serve borrowers who don’t meet the strict requirements of traditional lenders. These can include small business owners, independent developers, or entrepreneurs. By investing in these loans, investors can tap into a market underserved by large institutional lenders and benefit from higher demand for alternative financing.

Example: A local entrepreneur with a strong business plan for a co-working space secures a small-balance commercial loan to purchase a building. While traditional banks turned him down due to lack of collateral, a specialized lender sees potential in the business, offering the loan and generating returns from a borrower with high growth potential.

Take-away:

Investing in small-balance commercial real estate loans offers many advantages: lower barriers to entry, flexibility, diversification, and the potential for higher returns. For investors looking to enter the commercial real estate market or diversify their portfolios, small-balance CRE loans present an opportunity to gain exposure to a growing sector with manageable risk.

Interested in learning more? Reach out to discuss how small-balance commercial real estate loans can enhance your investment strategy!

Best,

Brandee