Commercial Retail Estate industry often works and depends on Loans and Finance options for acquiring, developing, maintaining, or constructing a commercial property. It is a debt-based contract in which CRE borrowers use these funds for non-residential properties. Commercial Real Estate Loans are different from Commercial Loans. The former category of loan is the one that CRE stakeholders look forward to and look for the best lending institutions. The latter category primarily deals in loans used for purchasing equipment or operating necessary expenses.
Loan Rates, Fees, and Time is taken for procurement.
It usually takes between 35-45 days to procure a Commercial Real Estate loan, but there are times when the time limit can exceed up to 120 days.
- Commercial Real Estate loans have a tenure of repayment, which is comparatively shorter than that of residential loans. The usual range of loan terms ranges between 6 months – 20 years, which depends on the type of loan taken and the financial institution providing the loan.
- Similarly, even the rate of interest is much higher than the interest offered for residential loans. The ROI depends on various factors like terms of the loan, amount of the loan, amortization period, and the credit strength of the investor. The longer the term, the higher will be the rate of interest.
- Interest charges also depend on the LTV (Loan to Value) ratio. The lower the LTV ratio, the lower will be the rate of interest.
- Fees like loan-application fees, legal and appraisal-related fees, and survey or loan origination fees need to be paid during the approval process of sanctioning the loan. Some of these charges can also be paid annually by the borrower.
- Repayment can get expensive for commercial real estate loan takers who can be negotiable in some cases.
- CRE loans can be fixed or variable depending on the type of loan taken.
Eligibility Criteria to Apply for a Commercial Real Estate Loan
Certain requirements need to be fulfilled before applying for a CRE Loan, and the borrower needs to focus on these areas:
1. Creditworthiness or the Credit (CIBIL) score
These loans are preferably made to business entities that require the principals of the business entity. The estate needs to meet certain criteria like FICO scores, which are authorized by credit reporting bureaus and credit scales.
The property for which the loan is taken is considered collateral security when the borrower defaults on making the payment. For this reason, commercial real estate lending is often based mostly on the loan-to-value (LTV) ratio, which measures the value of the loan against the value of the property being financed. Generally, a ratio of LTV between 65 – 80% will be eligible for financing.
3. Debt-Service Coverage Ratio
The property's DSCR – Debt Service Coverage Ratio is a significant factor that is considered before acquiring a loan on commercial real estate. DSCR is a formula that divides the NOI – Net Operating Income of the property by its principal and interest payments (annual mortgages debt service)
DSCR is either more than or less than 1. If it is more than 1, it indicates a positive trend and eligibility for a CRE loan.
4. Business Entity:
Before applying for financing methods to procure or maintain a commercial real estate loan, the firm needs to b registered as a business entity
5. Organized Paperwork:
This factor is overlooked, but the borrower must be ready with all the mandatory, business-related, personal, and legal documents before applying for the loan so that there is no risk of rejection.
Types of Commercial Real Estate Financing
Commercial real estate lending is a highly complex topic, and procurement of financing options is to purchase income-producing properties. These owners are looking for space to set up their businesses, upcoming projects, and other aspects. There are many CRE Loan and Financing options available in the market through many sources like:
This does not mean cash, but its either a wire transfer or a cheque of this amount which has certified funds from the bank or other lending organizations.
This is a traditional method of acquiring a loan, which means financing the investment property, which may promise higher returns than cash.
Banks, Credit Unions, or mortgage brokers don't use the capital of their own; instead, they borrow funds from another party or take a loan from the government to further lend it to the CRE enterprise. This kind of loan comes with strict rules and regulations.
The Federal Housing Administration (FHA) insures mortgages for banks. This means pooling money to spread the risk and is specially designed for homeowners who are going to live in that property.
Like an FHA loan, a 203k loan is taken for renovation, repair, or improvement within the house or property.
In this case, the owner of the property you wish to buy finances the property. Instead of paying to bans or other lending institutions, monthly installments are paid to the owner.
Hard money is obtaining a loan or finances from a person or a private business. These have different terms and conditions and can cost more with leverage in the application process.
This is another form of hard money. The main point of difference is that there is an established relationship between the borrower and the lender. They both are into this deal of financing for the profitability of both parties.
Home Equity Loans and Lines of Credit
Many CRE loans are taken based on the home equity or home line of credit.
An equity partner may offer to lend an extra share for CRE business, and he will be eligible for an interest that the company will owe to him.
Equity Indexed Universal Life Insurance (EIULS), Life Insurance, Roth IRAs, and Other Sources
There are many other investments and lending options.
Commercial Lending by Asset Type
Options to provide loans depend on the type of property that needs to be financed.
Let's look at the different loans that can be acquired for different asset types in CRE.
Financing for General Commercial Buildings
Most commercial buildings (office buildings, retail buildings, mixed-use spaces, etc.) share similar characteristics when it comes to financing, though some may differ.
Office Building Financing
These are quite stable in the market and have high occupancy rates and loyal tenants.
Hotels have volatile cash flow as they don't possess long term tenant leases. Most hotel lenders range between 55-60% of LTV.
Special-Use Property Financing
Properties like gas stations, dry cleaners, spa and fitness centers, restaurants, car washes, and other similar business types come under this category. It is expensive to convert these businesses to other uses; it could get challenging to finance these CREs down payments, additional security, high-end guarantees, and operating covenants could be required to obtain loans for these types of properties.
Residential properties can be four or fewer units that can be purchased using these loans. Duplexes, Triplexes, and multiplexes come under this category, and the loan is procured to buy these properties for investment.
Warehouses, storage land, or any other kind of Industrial real estate are among the top asset classes for both borrowers and lenders. These guarantee excellent returns and often get favorable investment opportunities.
Regardless of the other kinds of commercial real estate financing, land financing is quite difficult to procure as it is difficult to sell land. The land is also viewed as a higher risk commodity, which also has a lower LTV.
Commercial real estate loans are not that easy to procure and require proper documentation, adherence to terms and conditions, patience, and preparation, too, as large amounts of funds are involved. These are quite complicated and challenging due to the increased levels of risk involves. If the investors of CRE investors maintain their patience and perseverance, they may land with life-changing deals and financing options that can change the entire world of commercial real estate.
The following documents are required to take a loan for CRE:
- Completed loan application form duly filled and signed along with three Passport size pictures.
- Identity Proof: PAN/ Passport/ Driver’s License/ Voter ID card.
- Address Proof: Recent copy of Telephone Bill/ Electricity Bill/Water Bill/ Piped Gas Bill or copy of Passport/ Driving License/ Aadhar Card.
- Property Papers like Permission for construction, Registered Agreement for Sale, Occupancy Certificate, Share Certificate, Maintenance Bill, Electricity Bill, Property Tax Receipt, Approved Plan copy & Registered Development Agreement of the builder, Conveyance Deed, Payment Receipts or bank A/C statement.
Amortization is the specified time period in which a CRE loan is paid back in full.
Loan to Value Ratio is the value of the loan against the true value of the property for which the loan is taken. Generally, the loan value varies between 65-80% of the value of the property, depending on the kind of financing opted for and the credibility of the stakeholders.
DSCR is the property holder's ability to service the debt taken against the actual value of the property. It is calculated by dividing the NOI – Net operating income of the property by the annual debt undertaken.
CRE loans comprise various factors like legal and loan application fees, survey fees, loan origination, verification fees, and much more, so the cost is more than a residential loan.
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