What Investors Should Know About Commercial Real Estate Loans

Your commercial actual estate transaction does not close unless the loan is approved. You can also boost the money flow if the interest rate for the loan is low. So the more you know about commercial loans the superior selection you can make about your commercial actual estate investment.

Loan Qualification: Most of you have applied for a residential loan. You present to the lender with W2's and/or tax returns. In general the even more income you make the greater loan quantity you qualify. You could even borrow 100% of the acquire cost if your income or stated income is powerful. For commercial loan, the quantity of loan the lender will approve is based on the rental income of the property, not your private income. So the extra rental income the property generates, i.e. the higher the CAP rate, the greater loan to value (LTV) the lender approves. If you invest in a vacant commercial building, you will have tricky time receiving a loan as it does not have any rental income unless you strategy to occupy it for your home business.

Loan to Value: Commercial lenders tend to be more conservative about the loan to value. Most commercial lenders loan up 75% of the value of the property. The following is just a rough guideline for LTV based on the CAP rate as the actual calculation is beyond the scope of this post.

CAP ----- LTV
8% ----- 75%
7% ----- 67%
6% ----- 55%
5% ----- 45%

Lenders will only loan you the amount such that the income after expenditures, i.e. net operating income is at least 20-25% even more than the annual mortgage payment of the property. Or a different words, the loan quantity is such that you will have positive cash flow equal to at least 20-25% of the mortgage payment. So if you buy a property with low CAP rate, you will will need more down payment. This is so correct for commercial properties in California as the CAP rate is in the five% range. Commercial genuine estate is intended for the elite group of investors so there is no such factor as 100% financing.

Interest Rate: The interest for commercial is dependent on varied factors

1. Loan amount: In residential mortgage if you borrow less dollars, i.e. a conforming loan, your interest rate will be the lowest. When you borrow a lot more capital, i.e. a jumbo or super jumbo loan, your rate will be greater. In commercial mortgage, the reverse is correct! If you borrow $200K loan your rate could be 9%. But you borrow $3M, your rate could be only five.9%! In a sense, it is like getting lower price when you invest in an item in massive volume at Costco.
2. Property kind: the interest rate for a single tenant night club developing will be greater than multi-tenant retail strip for the reason that the danger is higher. When the night club constructing is foreclosed, it is much harder to sell or rent it compared to the multi-tenant retail strip. The rate for apartment is lower than shopping strip. To the lender, every person wants a roof over their head no matter what so the rate is lower for apartment.
3. Age of the property: loan for newer property will have lower rate than dilapidated 1. To the lender the danger factor for older properties is higher so the rate is greater.
4. Location: if the property is located in a growing location like Atlanta metro the rate would be lower than a comparable property located in the rural declining region of Arkansas. This is yet another cause you need to study demographic data of the region prior to you obtain the property.
5. Your credit history: similarly to residential loan, if you have fantastic credit history, your rate is lower.
6. The lenders you apply the loan with: Each and every lender has its own rates. There could be substantial distinction, e.g. over 1%, in the interest rates. So you really should work with somebody specialized on commercial loans to shop for the lowest rates.
7. Prepayment flexibility: If you want to have the flexibility to prepay the loan then you will have to pay greater rate. If you agree to maintain the loan for the term of the loan, then the rate could be 1% interest lower. See additional on conduit loan.

Prepayment Penalty: In residential loan, prepayment penalty is typically an option. If you don't want it, you pay higher rate. Most commercial loans have prepayment penalty. The prepayment penalty quantity is reduced or stepped down every year. For example on a 5 year fixed rate loan, the prepayment penalty for the initial year is 5% of the balance. It's lowered to four% and then 3%, 2%, 1% for 2nd, 3rd, 4-th and 5-th year respectively.

Loan Charges: In residential mortgage, lenders might possibly present you a "no points, no costs" choice if you pay a higher rate. Such alternative is not on the market in commercial mortgage. You will have to pay between ½ to 1 point loan fee, appraisal expense, atmosphere assessment report fee, and processing/underwriting fee. A lender usually issues to the borrower a Letter of Interest (LOI) if it is interested in lending you the funds. The LOI states the loan amount, interest rate, loan term and charges. Once the borrower pays all the fees, the lender starts underwriting the loan. If the lender approves the loan and you do not accept it then the lender keeps all the fees.

Loan Kinds: When there different commercial loan kinds, most investors frequently encounter 3 primary kinds of commercial loans:

• Small business Administration or SBA loan. This is a government guaranteed loan intended for owner-occupied properties. When you occupy 51% or far more of the space in the constructing (gas station is considered an owner-occupied property), you are qualified for this program. The key benefit is you can borrow up 90% of bought price.
• Portfolio loan. This is the kind of commercial loans the lenders loan to you employing their own cash. Lenders are quite often extra flexible for the reason that it's their dollars. For example United Commercial, Citi Bank or Cathay Bank is a portfolio lender.
• Conduit loan. It is harder to explain to an average consumer or investor what a conduit loan is. It is a lot easier identifying it by its characteristics or just basically ask the lender.
• The rate is regularly lower. It is sometimes about 1.two% over the five or ten year US Treasury rates compared to 1.85-three% over the 5 or 10 year US Treasury rates for portfolio loan. This is the key advantage of conduit loan.
• Conduit lenders only give consideration to major loan amount, e.g. at least $2M.
• Lenders require borrower to form a single-asset entity, e.g. Limited Liability Company (LLC) to take title to the property. This is intended to shield the property from other the borrower's liabilities.
• If the borrower later desires to sell the property prior to the lock out period expires, the new buyer must assume the loan as the seller can not pay off the loan. This makes it harder to sell the property given that the buyer demands to come up with a significant amount of money for the distinction between the acquire price and loan balance. Moreover, the lender could reject the loan assumption application for diverse causes as there are no incentives for it to do so. If you are a 1031-exchange buyer, you might possibly want to think twice about buying a property in which you need to assume the loan. Must the lender reject your loan assumption application, you might possibly end up not qualifying for the 1031 exchange and have to send to Uncle Sam a big capital acquire check. This is the hidden price of conduit loan.
• Even when you are allowed to prepay the loan, it expenses an arm and a leg if you want to prepay the loan. The prepayment penalty is quite often named Yield Upkeep or Defeasance. Fundamentally you have to pay the distinction in interest among the note rate of your loan and the existing US Treasury rate for the remaining years of the loan! This amount is regularly so high that the seller generally demands the buyer to assume the loan. You can compute the defeasance from defeasewithease.com web site. Besides the defeasance, you also have to pay a hefty processing fee which is in the $50-60K range! These are yet another hidden cost of conduit loan. Conduit loan may well be the loan for you if you intend to preserve the loan for the life of the loan that you agree to at the starting. Otherwise it could be very pricey due to its payoff inflexibility.

Lenders Coverage Location: commercial lenders would do business enterprise in areas they are familiar with. For example while Green Point Commercial does home business in Northern California, it does not cover Fresno or Sacramento County. United Commercial Bank will only contemplate properties in California. Provident Bank does business in Arizona, California and Nevada. Silver Hill Economic covers all 50 states but has a 1 million dollar loan limit. Kennedy Funding does business enterprise nearly anywhere but the rate is fairly high as it is a difficult-cash lender. GE Commercial Financing will only think about transaction with at least $5M loan.

Lenders Coverage Property Sorts: Most commercial lenders would only think about a specific types of properties that they are familiar with. For example Washington Mutual would do apartments and office buildings but not retail properties or gas stations. Citibank would not take into account loans for single tenant retail properties. Westford Financial specializes on church financing. Comerica concentrates on owner-occupied properties.

Conclusion:
Commercial loans are a lot more complex than residential loans. As an investor, you need to employ a professional commercial loan broker to help you with your commercial loan want. Probabilities are that you will finish up paying lower interest rates, avoiding possible pitfalls and getting a improved opportunity to get the loan approved.