Getting financing for your next big commercial real estate (CRE) project is all-important. But the type of financing you access can have a big impact on your project’s cashflow and therefore profitability. It’s essential that CRE investors and brokers have a basic knowledge of the types of commercial real estate financing available, who can access them, and the benefits and drawbacks of each.
We’ll cover five of the most common types of commercial real estate financing in this guide. Read on to up your investment game.
Things to Consider When Applying for Commercial Real Estate Financing
Unlike residential real estate, CRE usually revolves around properties that generate income in the form of monthly rentals. When looking for financing, a few factors CRE investors should consider include:
- Building Relationships: Establishing good relationships with lenders and financial brokers in the CRE sector can be beneficial. They can provide valuable insights and may offer better terms or suggest other financing options.
- Business Plan: Having a well-structured business plan including financial projections for your CRE investment is a must. It helps lenders understand the potential profitability and viability of your project.
- Cash Flow: The amount of cash flow your property generates may affect the loan amount and terms.
- Collateral: Lenders will often require guarantees as a form of security in case you are unable to repay your loan. Be prepared to discuss what assets can be used as collateral to secure the loan.
- Due Diligence: Always ensure you do your own thorough research before confirming a deal. Getting professional advice from CRE broker is always a good move. You can also access location insights tools like AlphaMap to help you with detailed demographic and property information.
- Loan Terms: Interest rates are usually proportional to the amount of risk involved in a project. Borrowers will need to become familiar with other terms like loan-to-value ratios (LTVs), debt service coverage ratio (DSCR), gross yield, return on investment (ROI), and more.
- Ownership Structure: Decide on the ownership structure for your property. CRE loans are typically granted to companies and not individuals.
- Property Experience: More experienced CRE investors and developers will have access to better lending options because lenders see property experience as reducing the risk of failure.
- Regulations: Lending laws and regulations can differ from state to state, so it’s essential you chat to a broker who understands the laws in the local area of your property.
- Risk Profile: The type of project you are taking on will affect your risk profile. For example, financing for an already established office block with a solid rental income will be considered less risky than an extensive refurbishment to a retail and entertainment centre in a run-down area. The latter investor will likely have access to fewer lending options for their project.
5 Ways to Access Commercial Real Estate Financing
Here are some of the most common ways to access finance for commercial real estate projects:
1. Traditional Bank Loans
Traditional banks are usually the first port of call when accessing CRE financing. These big banks have very strict eligibility criteria, which might make this option inaccessible to certain types of borrowers.
Lending criteria include assessing:
- Your credit score
- Business financials
- Personal and business collateral
- Viability of your CRE project
Pros: Competitive interest rates, longer repayment terms, and larger loan amounts
Cons: Lengthy approval process, stringent criteria, and potential for personal liability
Opt for a traditional bank loan if you have a strong credit profile, substantial collateral, and a solid business plan. However, if time is of the essence, or if you’re new to the CRE investment space, you might need to explore other financing avenues.
2. SBA Loans
SBA loans are guaranteed by the US Small Business Administration (SBA). You could get access to an SBA 7(a) loan which can be used for acquiring, refinancing, or improving real estate and buildings, short- and long-term working capital, buying machinery and equipment, and funding furniture and fixtures. The maximum amount you can secure from this type of loan is $5 million.
An SBA 504 loan can give you access to long-term, fixed-rate finance for major fixed assets like buildings and equipment. The maximum you can borrow on this type of loan is $5.5 million. These loans are specifically for fixed assets and cannot be used for working capital or debt.
Pros: Lower down payments, competitive interest rates, longer repayment terms
Cons: Strict eligibility criteria, lengthy approval process
SBA loans are an option for those with a strong credit record but limited capital. They are ideal for long-term investments due to their favorable terms. An experienced finance broker can help you gain access to and navigate the complexities of SBA loans.
3. Private Lenders
It’s not always possible for CRE investors to get access to traditional forms of financing. Fortunately, there are many private options around who offer less stringent eligibility criteria and faster approval processes. These lenders are willing to take on more risk usually in return for a higher interest rate. This makes them suitable for short-term lending options or bridging finance.
Pros: Quicker access to funds, Flexibility on terms
Cons: Higher interest rates, shorter repayment terms
For new investors who haven’t yet established a solid credit record, or those with a less-than-perfect credit record, private lenders are a good option. Just bear in mind that due to the higher costs they are best only for short-term financing needs. It’s best to refinance with a more mainstream lender, on more favorable terms, as soon as possible.
4. Real Estate Crowdfunding
Real estate crowdfunding has grown in popularity in the last ten years or so. In 2012, the Jumpstart Our Business Startups (JOBS) Act opened up opportunities for all types of real estate investors (including non-accredited investors) to get a stake in CRE through crowdfunding platforms.
In essence, crowdfunding relies on a group of investors to each contribute to a project in exchange for a portion of equity. The amount of equity is proportional to the amount of money invested.
Crowdfunded CRE projects could consist of just a handful of investors, all the way to thousands, depending on the project.
There are hundreds of CRE crowdfunding platforms to choose from, but they aren’t all equal. Make sure you research the track record of the platform, delving into their years of investment experience and online reputation. Some well-known and trusted crowdfunding sites in US include RealtyMogul, Crowdstreet, and EquityMultiple.
Pros: Lower entry barriers, diversification opportunities, ability to invest in projects otherwise inaccessible
Cons: Risk of platform failure, lesser control over the investment, long-term nature of commitments
Taking part in CRE crowdfunding can be a great way for a new investor to get their toes wet in the market by starting with a small investment capital.
5. Mortgage REITs (Real Estate Investment Trusts)
A mortgage real estate investment trust, or mREIT, is an entity that finances or owns CRE mortgages rather than directly owning properties. mREITs, and their investors, earn income from the interest on the mortgage they hold or finance.
For CRE developers, mREITs present an alternative financing route, often with more favorable terms compared to conventional bank loans. However, there's a degree of risk as the interest rates may fluctuate, and the stability of the loan is tied to the financial health of the mREIT.
Pros: Accessible financing, potentially favorable loan terms, may not need large upfront capital
Cons: Sensitivity to interest rates, dependency on mREIT's financial stability
mREITs are usually a good option for those who aren’t able to access conventional lending due to their risk profiles or negative credit records.
5 Types of Commercial Real Estate Financing Compared
Final Thoughts on Accessing Commercial Real Estate Financing
Unlike residential real estate, CRE financing options are much more varied and nuanced – it’s a challenging terrain to navigate.
The key to finding the right type of financing for your project is firstly, arming yourself with knowledge, and secondly having a clear plan and goal in mind. You need to align your financing options with your project’s financial outlook, your risk tolerance, and your long-term investment objectives. If in doubt, seek professional advice from your CRE broker, who can help to ensure you make the wisest choice possible.