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- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
What is a Commercial Real Estate Loan?
Income-producing property that is exclusively used for business instead of residential purposes is known as Commercial real estate (CRE).
Retail malls, shopping centers, office buildings and complexes, and hotels are examples of commercial real estate.
A commercial real estate loan accomplices the task of financing (including the acquisition), development, and construction of these properties.
In short commercial real estate loans are mortgages secured by liens on the commercial property.
Borrowing for commercial real estate is different from a home loan
Just like your home mortgages, banks and independent lenders provide commercial real estate loans.
Finance for commercial real estate is also provided by insurance companies, pension funds, private investors, and other sources, like the U.S. Small Business Administration’s 504 Loan program.
Loan repayment schedules
The commercial loan terms range from 5 years to 20 years, and often the amortization period is longer than the term of the loan.
For instance, a lender might take a commercial loan for a period of 7 years and an amortization period of 30 years.
So the investor would make payments for 7 years of an amount depending on the loan being paid off over 30 years, followed by one final balloon payment for the entire remaining amount on the loan.
Loan-to-value ratios
A loan to value ratio (LTV) measures the value of a loan against the value of the property.
In commercial real estate loans, a lender calculates LTV by dividing the amount of the loan by the lesser of the property’s appraised value or its purchase price.
For instance, a $90,000 loan’s LTV on a $100,000 property would be 90% ($90,000 ÷ $100,000 = 0.9, or 90%).
Lower the LTV the more possibility to qualify for favorable financing rates. LTVs, for commercial loans generally fall into the 65% to 80% range.
A particular LTV depends on the loan category.
Debt-service coverage ratio
A debt service coverage ratio (DSCR), compares a property’s annual net operating income to its annual mortgage debt service that includes principal and interest.
So the property’s ability to service its debt can be measured. Commercial lenders also calculate it by dividing the NOI by the annual debt service.
Rates and fees for commercial real estate loans
Compared to residential loans the interest rates on commercial loans are generally higher.
Appraisal, legal, loan application, loan origination, and/or survey fees are the additional fees that are added to the overall cost associated with commercial real estate loans.
Some costs have to be paid before the loan is approved or rejected, whereas the others are to be paid annually.
For instance, at the time of closing, there may be a one-time loan origination fee of 1%, and an annual fee of 0.25% until the loan is paid fully.
A $1 million loan, might attract a 1% loan origination fee that is $10,000 to be paid upfront and a 0.25% fee of $2,500 paid annually along with the interest.
Prepayment
To preserve the lender’s anticipated yield on a loan a commercial real estate loan may have restrictions on prepayment.
If the debt is settled before the loan’s maturity date the investors will likely have to pay prepayment penalties. There are four basic types of penalties if the loan is paid off early:
- Prepayment penalty: This basic prepayment penalty is calculated by multiplying the current outstanding balance by a specified prepayment penalty.
- Interest guarantee: Even if the loan is paid off early the lender still is entitled to a specified amount of interest. For instance, a loan may have a 10% interest rate guaranteed for 60 months and a 5% exit fee after that.
- Lockout: The borrower cannot pay off the loan before a set period of time, like a five-year lockout period.
- Defeasance: It is a substitute for collateral. Instead of paying cash to the lender, the borrower exchanges new collateral like the U.S. Treasury securities, in place of the original loan collateral. Even if it reduces fees this method of paying off a loan attracts high penalties.
The commercial real estate loan documents contain prepayment terms and can be negotiated with other loan terms.
Conclusion
In commercial real estate, an investor purchases the property leases it out and collects rent from them.
The purpose of commercial real estate lending is to be an incoming producing property.
Lenders consider the loan’s collateral, the creditworthiness of the owners, along with three to five years of financial statements and income tax returns, and financial ratios like the loan-to-value ratio and the debt-service coverage ratio to evaluate commercial real estate loans.
Thanks for pointing out that getting a loan for buying commercial property is very different compared to one of a home. I’m interested in looking for a commercial real estate company soon because I’d like to invest on property that can be leased to businesses. I think that would be the best way for me yo earn money passively once I grow old.