Commercial real estate loan
Commercial real estate (CRE) is income producing goods used only for commercial (rather than residential) purposes. Examples include shopping malls, shopping malls, office buildings and complexes, and hotels. Financing, including the acquisition, development and construction of these properties, is generally achieved through commercial real estate loans: mortgages secured by privileges on commercial property.
What is a commercial real estate loan?
Just like with residential mortgages, banks and independents lenders are actively involved in lending on commercial real estate. Also, insurance companies, pension funds, private investors and other sources, including the US Small Business Administration 504 Loan Program, to bring Capital city for commercial real estate.
Here we examine commercial real estate loans, how they differ from home loans, their features and what lenders are looking for.
Explain commercial real estate loans
Residential loans and commercial real estate loans: the main differences
Commercial real estate loans are generally made to commercial entities (corporations, developers, limited partnerships, funds and trusts).
Commercial loans typically range from five years or less to 20 years, with the amortization period often being longer than the term of the loan.
Loan-to-value ratios for commercial loans are typically between 65% and 80%.
Residential mortgages are generally made to individual borrowers.
Residential mortgages are amortized loans where the debt is paid off in regular installments over a period of time. The most popular residential mortgage product is the 30-year fixed rate mortgage.
High loan-to-value ratios, even up to 100%, are allowed for some residential mortgages, such as USDA or VA loans.
Individuals vs. Entities
While residential mortgages are typically made to individual borrowers, commercial real estate loans are often made to commercial entities (e.g., corporations, developers, limited partnerships, funds and trusts). These entities are often incorporated for the specific purpose of owning commercial real estate.
An entity may not have a financial history or credit rating, in which case the lender may require the directors or the owners of the entity to guarantee the loan. This gives the lender an individual (or a group of individuals) with a credit history—And from whom they can recover in the event of a loan fault. If this type of guarantee is not required by the lender and the property is the only means of recovery in the event of default, the debt is called a loan without recourse, which means that the lender does not have appeal against anyone or anything other than property.
Loan repayment schedules
A residential mortgage is a type of amortized loan in which the debt is repaid in regular installments over a period of time. The most popular residential mortgage product is the 30-year loan fixed rate mortgage, but home buyers have other options as well, including 25 and 15 year mortgages. Longer amortization periods generally involve smaller monthly payments and a higher total interest charges over the life of the loan, while shorter amortization periods typically result in larger monthly payments and lower total interest charges.
Residential loans are amortized over the life of the loan so that the loan is fully repaid at the end of the loan term.
A buyer of a $ 200,000 home with a 30-year 3% fixed rate mortgage, for example, would make 360 monthly payments of $ 1,027, after which the loan would be fully repaid. These figures assume a deposit of 20%.
Unlike residential loans, commercial loan terms typically range from five years (or less) to 20 years, and the amortization period is often longer than the loan term. A lender, for example, could make a commercial loan for a period of seven years with an amortization period of 30 years. In this situation, the investor would make payments for seven years in an amount based on the loan repayment over 30 years, followed by a final payment. “balloon payment of the entire remaining loan balance.
For example, an investor with a $ 1 million 7% commercial loan would make monthly payments of $ 6,653.02 for seven years, followed by a balloon payment of $ 918,127.64 which would repay the loan in full.
The length of the loan and the amortization period affect the rate charged by the lender. Depending on the creditworthiness of the investor, these conditions may be negotiable. In general, the longer the loan repayment schedule, the higher the interest rate.
Another difference between commercial and residential loans is the loan-to-value ratio (LTV), a number that measures the value of a loan in relation to the value of the property. A lender calculates the LTV by dividing the loan amount by the lesser of expertise value or his purchase price. For example, the LTV for a $ 90,000 loan on a $ 100,000 property would be 90% ($ 90,000 ÷ $ 100,000 = 0.9 or 90%).
For commercial and residential loans, borrowers with lower LTVs will be entitled to lower finance rates than those with higher LTVs. The reason: they have more equity (or interest) in the property, which equates to less risk in the eyes of the lender.
High LTVs are allowed for some residential mortgages: up to 100% LTV is allowed for Virginia and USDA loans; up to 96.5% for FHA loans (loans insured by the Federal Housing Administration); and up to 95% for conventional loans (those guaranteed by Fannie Mae Where Freddie mac).??
LTVs for commercial loans, on the other hand, are typically between 65% and 80%.While some loans can be made at higher LTVs, they are less common. The specific LTV often depends on the loan category. For example, a maximum LTV of 65% may be allowed for earthen, while an LTV of up to 80% might be acceptable for a multi-family construction.
There are no VA or FHA programs in commercial loans, and no private mortgage insurance. Therefore, lenders have no insurance to cover the borrower’s default and must rely on the real estate promised as Security.
Debt service coverage ratio
Commercial lenders are also looking at Debt service coverage ratio (DSCR), which compares the properties annual net operating income (NOI) to his annual mortgage debt service (including principal and interest), measuring the property’s ability to service its debt. It is calculated by dividing the NOI by the annual debt service.
For example, a property with $ 140,000 in NOI and $ 100,000 in annual mortgage debt service would have a DSCR of 1.4 ($ 140,000 ÷ $ 100,000 = 1.4). The ratio helps lenders determine the maximum loan amount based on the cash flow generated by the property.
A DSCR less than 1 indicates negative cash flow. For example, a DSCR of 0.92 means that there is just enough NOI to cover 92% of the annual debt service. In general, commercial lenders look for DSCRs of at least 1.25 to ensure adequate cash flow.
A lower DSCR may be acceptable for loans with shorter amortization periods and / or properties with stable cash flow. Higher ratios may be needed for properties with volatile cash flows, e.g. hotels, which do not have the long term tenant (and therefore more predictable) leases common to other types of commercial real estate.
Interest rates and fees for commercial real estate loans
Interest rates on commercial loans are generally higher than on residential loans. In addition, commercial real estate loans generally involve costs that are added to the overall cost of the loan, including Evaluation, legal, loan application, loan arrangement and / or investigation costs.
Some costs must be prepaid before the loan is approved (or rejected), while others apply annually. For example, a loan can have a single loan creation a 1% fee, due at the time of closing, and an annual fee of one quarter of a percent (0.25%) until the loan is fully repaid. A loan of $ 1 million, for example, may require an upfront payment of 1% loan origination fee equal to $ 10,000, with a 0.25% fee of $ 2,500 paid annually (in addition to interest. ).
A commercial real estate loan may have restrictions on prepayment, designed to preserve the lender’s expectations yield loan. If investors pay off debt before loan maturity due date, they will likely have to pay prepayment penalties. There are four main types of “exit” penalties for early repayment of a loan:
- Penalty for early repayment. This is the most basic early repayment penalty, calculated by multiplying the current outstanding balance by a specified prepayment penalty.
- Guarantee of interest. The lender is entitled to a fixed amount of interest, even if the loan is prepaid. For example, a loan may have an interest rate of 10% guaranteed for 60 months, with a rate of 5% exit fees after that.
- Locking. The borrower cannot repay the loan before a specified period, such as a five-year lockout.
- Cancelation. A substitution of collateral. Instead of paying cash to the lender, the borrower exchanges a new collateral (usually US Treasury securities) for the initial guarantee of the loan. It can reduce the cost, but high penalties can be attached to this method of loan repayment.
Prepayment terms are identified in loan documents and can be negotiated with other loan terms for commercial real estate loans.
The bottom line
With commercial real estate, an investor (often a commercial entity) purchases the property, leases the space, and collects rent from the companies that operate in the property. The investment is intended to be an income producing asset.
When evaluating commercial real estate loans, lenders take into account the loan collateral, the solvency entity (or principals / owners), including three to five years of financial state and income tax returns, and financial ratios, such as loan-to-value ratio and debt service The coverage ratio.