Financing Commercial Properties

If you're an investor, developer, rehabber or virtually anyone interested in acquiring any type of commercial property, your project will most likely require a commercial real estate loan of some type. These types of loans resemble residential mortgages in many ways but do have some major differences that you really need to understand before you start seeking financing for your project.

Here's a breakdown of some of the things you need to know before you run out and start applying for financing:

LTV (Loan-to-Value Ratio) & DSCR (Debt service coverage ratio)

The LTV is simply a number or metric that a lender uses to determine how much they can lend on the property. It is the ratio of the property's value to how much they will loan on the property. (Loan Amount/Property Value).

On residential properties the LTV could be quite high, sometimes up to 100% if you qualify for some type of government program. With commercial properties the LTV is much lower, typically in the 75 -80% range. This being the case, you will need to have 20-25% for a down payment or purchase the property at a considerable discount so that if falls within the LTV limit.

Another important metric is the DSCR (Debt service coverage ratio). Most lenders (60%) use the LTV metric. The remaining lenders (40%) use the DSCR metric. This is a metric that considers the borrowers ability to makes it's debt payments with its existing cash flow. The calculation is Annual NOI / total annual debt payments. NOI stands for net operating income. The median DSCR in the industry today is 1.25.

Non-Recourse Loans vs Personal Guarantees

In both cases, residential and commercial, the lender utilizes the property being purchased as collateral for the loan. In many cases it might also require a personal guarantee by the buyer.

For a non-recourse loan the lender will not require a personal guarantee. This means that you, as the buyer, will not be responsible for any additional money beyond the value of the property itself in the event the lender has to take back the property if you default on the loan. The property itself is the only means the lender has to recover its investment. The lender has no recourse.

If you don't have sufficient experience, track record or just haven't been in business long enough, the lender may require you to personally guarantee the loan. What this means is that if you default on the loan and the lender has to take back the property or you simply can't make the payments, you will be personally responsible to make up the shortcomings.

Types of Commercial Financing -

1. Long-Term Permanent Financing
2. Lines Of Credit
3. SBA Loans
4. Bridge Loans
5. Hard Money Loans
6. Owner Financing

Long-Term Permanent Financing - These types of loans are very much like traditional residential mortgages. They are usually first position loans with an amortization schedule with repayment terms of 5 or more years. They are typically not available for short term financing or acquiring unstabilized, vacant or new construction. These loans are available from commercial lenders, banks and credit unions.

Lines Of Credit - These types of loans are typically available from private lenders only and not conventional banks. They can be used in a wide variety of situations such as new purchases, rehabs, fix & flips, commercial acquisitions, portfolio lending and new construction.

This type of funding is typically available for more experienced investors that have already successfully completed multiple projects. They range in size from $75k up to > $100MM. They are typically short term funding options with terms of 8-12 months with extensions available. There are minimums on the draws and minimum credit score requirements by the borrowers. They are valuable funding sources for experienced investors that do multiple deals and need funding readily available to take advantage of opportunities.

SBA Loans - The?US Small Business Association provides guarantees for some commercial real estate loans, and these loans are often called?SBA Real Estate Loans.There are two loan programs under which you can get commercial real estate financing: SBA 7(a) loans and SBA 504 loans. Real estate investors are not eligible for these loans.

• SBA 7(a) Loans
• The SBA 7(a) loan program is more general in nature, and business owners have a lot of flexibility in how they can use the funds. The loan is even available for non-real estate financing needs, including purchasing inventory and providing working capital.
• Also, SBA 7(a) loans are provided through a single private commercial lender, and up to 85% of the loan amount is guaranteed by the SBA. Down payment requirements start at 10% but can be much higher depending on the lender and the circumstance.
• SBA 504 Loans
• With the SBA 504 program, small business owners must use the funds to finance the purchase of commercial real estate or machinery and equipment, renovate an existing commercial property, or refinance an eligible commercial real estate or construction loan.
• Also, SBA 504 loans are provided through two lenders: a private commercial lender, which provides 50% of the project costs, and a certified development company (CDC), which provides 40%, all of which is guaranteed by the SBA. You provide the remaining 10% as a down payment, though some situations may require more than that amount.

Bridge Loans - These are short-term real estate loans used by real estate investors that are acquiring value-add properties that first need to be rehabbed, stabilized, etc. Once the properties are stabilized or rehabbed, long-term financing is then secured to "take-out" the short term financing. Commercial loan brokers are a great resource to assist you in acquiring the funding and navigating through the oftentimes confusing world of commercial financing.

Hard Money Loans - These are loans used by real estate investors in situations where they are unable to secure conventional bank financing or long term loans. They are not provided by conventional banks, but through private lenders and private loan companies. They are short-term loans just like bridge loans (typically between 3-36 months) where the investors are quickly rehabbing and flipping the properties or holding them as long-term rentals. When the properties are finished and rented, long-term financing is secured. A great resource in the BRRRR world (Buy, Rehab, Rent, Refinance, Repeat investment strategy)

Owner Financing - This is a great alternative for both buyers and sellers. This is where the seller of the property agrees to "carry back" or hold a note for some or all of the funding required to purchase the property. The seller and the buyer can agree on terms that are a win-win for both parties and allow a transaction to happen that otherwise wouldn't for any number of reasons.

It allows the buyers to purchase properties with favorable financing (terms and interest rate) directly from the seller where they might have otherwise been turned down by a conventional bank. The seller gets a steady stream of passive income for the term of the note and possibly a ballon payment at some time in the future. The buyer gets a property at terms he/she can afford without going through all of the formalities required by a conventional bank.

So, we’ll leave it there for now. I’ve provided the basics of what commercial financing is and the types of loans available as well as how it could be used in the various scenarios you may encounter.

In my next article will we’ll expand on the pros and cons of commercial real estate financing and the mechanics of applying for and securing commercial financing for your projects.?

Until then I hope you got some value out of the article. Keep doing those deals. Do your research, build your team, get some great advisors on your team. Above all, don't wait until you think you are an expert to forge ahead. Always remember the following quote:

Please feel free to reach out to me any time at [email protected]