When purchasing a commercial real estate investment it’s critically important to obtain optimal financing. Not only will finding the right lender and loan save you money, it will ensure that you achieve your long-term business goals and provide the financial flexibility needed to grow your business and returns.
So, how do you ensure that you lock yourself into the best commercial real estate loan? It involves doing your research, shopping around and comparing lender offers, and determining what makes the most financial sense for your situation. As part of that research, it’s important to start at the heart of CRE financing…and that means understanding the three components of a commercial real estate loan.
The nuts and bolts of a commercial real estate loan
In order to get the best possible financing from a lender, you will first need to understand the three major parts of a commercial real estate loan.
The loan term is another way of saying repayment term and schedule. Commercial real estate loans are offered with two types of terms: (i) Intermediate-term loans which last three (3) years or less, and (ii) Long-term loans which last anywhere from five (5) to 20 years.
These two term lengths are typically offered in two different types of commercial real estate loans: (i) an Amortized loan, and (ii) a Balloon loan.
- Amortized Loan: This type of loan is typically a long-term loan and is the kind we are all used to seeing in residential mortgages. It involves the borrower repaying the full amount of the loan (plus interest) in fixed installments over a set period of time. Ex. If you borrowed $100,000 at 2% interest for 20 years you would pay $283.33 each month until the end of the term. ($100,000 + 2% interest [$2,000] = $102,000 / 240 months)
- Balloon Loan: These types of loans are typically offered as an intermediate-term loan with terms of 5 to 7 years, sometimes up to 10. The key difference between a balloon loan and an amortized loan is that a balloon loan requires the borrower to pay off the remaining principal at the end of the term in one lump payment. While this loan still involves fixed installments, those installments aren’t set up to repay the entire loan amount. Instead those fixed payments are calculated as if it was a 20-30 year mortgage instead of a 5 to 7 year. This means at the end of the loan term the last payment is pretty large. This option is only good for borrowers who know they will have a lot of cash on hand at the end of the loan.
First things first, as a general rule of thumb interest rates offered for commercial real estate properties are going to be higher than purchasing residential real estate. The reason for this is because the risk is much higher and businesses have less credit history than individuals.
Second, the interest rate you eventually earn depends on the below factors:
- The type of commercial real estate property
- The type, financial health and creditworthiness of your business
- The loan-to-value (LTV) ratio, which measures the loan value against the purchased property value. Ex. You’re purchasing a $100,000 building. Lenders typically require a down payment of 20-30%, which equals an LTV of 70-80%. Higher LTV’s mean higher interest rates.
- The type of real estate lender
The following list from Whista provides the current average rates from various types of lenders:
- Conventional Bank Loan: 3.5-8%
- SBA 504 Loan: 4.5-5.5%
- SBA 7(a) Loan: 6-8.5%
- Life Company Loan: 3.5-4.5%
- CMBS Loan: 3.5-5.5%
- USDA Loan: 5.5-6.5%
- Fannie Mae Multifamily Loa; 4-5.5%
- Soft Money Loan: 6.5-12%
- Commercial Hard Money Loan: 10-21%
In addition to interest rates you will also have to pay various upfront fees, or closing fees, upon execution of your loan. These costs typically range from .5 to 2% of the loan amount and are sometimes required before the loan is approved, but most often bundled into the overall annual payment.
Typical fees included in the closing costs are for:
- Loan application
- Loan origination
- Property appraisal
- Property inspection
- Environmental assessment
- Title insurance
- Underwriting services
- Legal expenses
In order to avoid any surprises or confusion you should always ask your lender for a clear breakdown of all costs. This will help you avoid hidden costs like astronomical application fees.
Looking for commercial real estate investments in Milwaukee or surrounding markets?
Obtaining optimal financing is just one part to completing a successful commercial real estate purchase. In order to ensure you position a property for current and future success it’s crucial to properly evaluate the asset and negotiate the best deal. The only way to do this is to work with a licensed commercial real estate Broker. Not only will they have access to the most listings, they have the market insight and transaction experience to ensure your interests are being met. If you are seeking to invest in the metropolitan Milwaukee area then let the experts at SVN | Hintze Commercial Real Estate help you see high returns. Contact them today to get started!