What is a Commercial Real Estate Loan
A commercial real estate loan is a mortgage loan secured by a lien on commercial, rather than residential, property. Commercial real estate (CRE) refers to any income-producing real estate that is used solely for business purposes, such as retail centers, office complexes, hotels and apartments.
Typically, an investor (often a business entity) purchases commercial property, leases out space, and collects rent from the businesses that operate within the property. Financing, including the acquisition, development and construction of these properties, is typically accomplished through commercial real estate loans. Commercial real estate loans are typically made to business entities formed for the specific purpose of owning commercial real estate. Entity types include corporations, developers, partnerships, funds, trusts, and real estate investment trusts or REITs.
BREAKING DOWN Commercial Real Estate Loan
Like residential loans, banks and independent lenders are actively involved in making loans on commercial real estate. In addition, insurance companies, pension funds, private investors and other capital sources, including the U.S. Small Business Administration’s 504 Loan Program, make loans for commercial real estate. And, like residential lenders, various commercial lenders have different levels of risk that they will undertake. As a result, lenders have different terms they are willing to offer to borrowers.
While the most popular residential loan is the 30-year fixed-rate mortgage, the terms of commercial loans typically range from five years (or less) to 20 years, and the amortization period is often longer than the loan term. For example, a lender might make a commercial loan that is for a term of seven years with an amortization period of 30 years. This means that the borrower makes monthly payments during the seven years, in an amount determined as if the loan were being paid off over 30 years, followed by one final “balloon” payment of the entire remaining balance on the loan.
When evaluating commercial real estate loans, lenders consider the loan’s collateral, the creditworthiness of the entity (or principals/owners), including three to five years of financial statements and income tax returns; and financial ratios, such as the loan-to-value ratio and the debt-service coverage ratio.
Types of Commercial Real Estate Loans
The following are some of the most common types of commercial real estate loans:
- Permanent Loans are basic first mortgages on a commercial property. A permanent loan must have a degree of amortization and a term of at least five years written into the contract.
- SBA Loans are written by traditional and non-traditional lenders but are guaranteed by the Small Business Administration (SBA). There are several different SBA loans catered to different types of borrowers.
- Bridge Loans provide a short-term first mortgage loan on commercial property with a term usually from six months to three years. Bridge loans are typically obtained when a borrower is waiting for longer-term financing or attempting to remove an existing obligation.