Loan Types to Consider When Buying a Commercial Property
So, you’ve decided to purchase a commercial real estate building and now you need to find a suitable loan, right?
As an investor, you should know that there are a few different ways to finance commercial real estate investments along with specific criteria that must be met. Choosing the wrong kind of loan can impact the bottom line, so understanding your options is important.
Every loan type will have its own set of pros and cons and your financing approach will depend on the property and the situation. It’s important to remember that not all real estate investment financing options are created equal. Here are some common financing options available for commercial properties.
CONVENTIONAL LOAN: A conventional loan is a mortgage that is provided by a bank, credit union or other traditional financial institution and is secured by a first lien position on the property being financed. The collateral may be any type of commercial real estate and does not always require previous experience. A conventional mortgage is most commonly used when purchasing a stabilized investment property. Lenders will generally loan up to 75% of the property’s purchase price, with some going up to 80%. Competitive fixed-rate mortgages are offered for 5, 7 or 10-year terms and are amortized over a long period, such as 20, 25, or 30 years. These loans often include some sort of a step down prepay schedule that would come into effect should the property be sold or refinanced before the end of the loan term. The timing for a conventional loan to close is generally 60 to 90 days after a term sheet is issued.
BRIDGE LOAN: Bridge loans or hard money loans, are short term financing options that are typically funded by a private lender rather than a large national bank. These loans are used as an interim financing tool to buy properties in specific situations such as:
- Properties that are not stabilized
- Properties that need renovation
- Properties that require a fast closing, sometimes within weeks
Unlike conventional loans, bridge loans feature a faster closing process and higher leverage anywhere from 75% – 90% of a property’s purchase price. Bridge Loans are interest only (which means that the loan amount will never be paid down and will have to be paid off at maturity). Interest rates are much higher than a conventional loan, often between 8-12%.
CMBS LOANS: A CMBS loan is a fixed-rate investment product secured by commercial real estate. This loan type is always non-recourse and requires the borrower to execute a “bad boy guaranty” (a/k/a recourse carve out guaranty). This clause provides for personal liability against the borrower if certain bad acts are committed such as fraud or misuse of funds. CMBS loans are all pooled together and once securitized, they are sold off to investors. But not to worry, this loan is serviced similar to any other commercial real estate loan product. They are also often times able to be partially-interest only or even full-term interest only, which can enhance your cash flow. It should also be noted that CMBS loans are usually priced over the SWAP rate, as opposed to treasury rates. Lastly, these loans are known to have more relaxed sponsorship financial requirements compared to the other loan types and are generally more asset-based, making them accessible to a much wider variety of borrowers.
AGENCY LOANS: Fannie Mae and Freddie Mac, both government sponsored agency lenders are great options for those looking to purchase properties such as multifamily, affordable housing, student housing and healthcare facilities. Agency lenders feature highly competitive rates, are non-recourse, and can be leveraged up to 80% LTV. These loans are all amortized over 30 years and feature terms of 5, 7, 10 or 12 years. The major difference between traditional CRE loans and Agency loans, is that the prepayment penalty for an agency loan is yield maintenance. Yield maintenance is a form of prepayment that allows the lender to attain the same yield as if the borrower were to make all scheduled interest payments.
Choosing the right financing is an important component to real estate ownership and the loan choice will be dependent upon factors including:
- the asset type (multi-family, industrial, retail, office, etc.)
- if the property is stabilized or in transition
- your planned holding period
- tenant composition and lease terms
As a mortgage advisory firm for over 30 years, Progress Capital has been assisting commercial real estate owners, investors and business owners in the capital markets to arrange financing for their investment properties. Our team has long-standing relationships with significant commercial lending sources. We leverage these relationships to ensure our clients are aligned with the most competitive financing available in the market for their unique needs.
Eddie Miro is a Financial Analyst at Progress Capital and is available to advise you on any real estate investments you are considering, as well as help you manage through the commercial real estate acquisition and/or financing process.
