A Guide to Commercial Real Estate Loans

Commercial real estate loans are for the purchase, or renovation, of commercial properties recognized as owner-occupied real estate—meaning that at least 51% of the property must be inhabited by the business. Office buildings, retail centers, mixed-use buildings, industrial warehouses, apartment complexes, the car wash that Walt and Skyler bought in Breaking Bad—all commercial properties (though that last one was, ahem, a cash deal requiring no commercial loan; not the best example).

Any property that’s designated to make money is commercial real estate. It’s not the same as a residence, and commercial real estate loans are different from residential mortgages. Commercial business loans, because of the higher risk factor of small businesses, come under more scrutiny and require detailed business plans. In contrast, for a residential mortgage, a bank probably isn’t going to ask you what you have in mind for the living room’s feng shui.

Commercial real estate loans also come with shorter repayment terms than residential loans; a negotiable range of 5 to 20 years is the norm, as opposed to a 30-year home mortgage. Due to these shorter loan terms, there are also stiffer penalties in place for early payment on commercial real estate loans to protect the lender’s final take. Residential and commercial real estate market properties do, however, have one major factor in common: no amount of money can overcome an ill-selected location, location, location, so search and choose wisely (we recommend checking out Loopnet.com).

There are several categories of commercial real estate financing, but we’ll be focusing on the three most pertinent to small-business owners: traditional commercial mortgages, SBA 7(a) loans, and CDC/SBA 504 loans. As mentioned before, all three require on-premise occupancy by at least 51% of the business, repayment terms of around 5 to 20 years, and solid business plans.

Unlike the other two types of loans to be covered here, traditional commercial mortgages are not backed by the federal government—they’re loans made strictly between the borrower and the bank. As such, these mortgages have no mandated cap; it’s up to the lender to decide the maximum loan amount.

Typically, that maximum amount is determined to be between 65% to 85% of the real estate’s loan-to-value (LTV) comparison, with a down payment covering 15% to 35% of the fair market value of the property. Interest rates on traditional commercial loans range from 4.75% to 6.75%, and monthly payments are amortized over the duration of the loan’s term.

While traditional commercial mortgage loans require a higher personal credit score (700 or higher) than the government-backed options, they also call for fewer years in business (usually one, as opposed to three or more). Since the government isn’t sharing in the risk, banks and commercial lenders hold these types of loans to a higher qualification standard. If your business is already well established and profitable with a solid credit score, a traditional commercial mortgage would be your best bet.

Should you be turned down for a traditional commercial mortgage, a government-backed SBA (Small Business Administration) loan would be a viable next option—in fact, being rejected for a standard bank loan is one of the perquisites for an SBA loan. The interest rates are typically lower with SBA loans, as are the credit score requirements, but the qualification guidelines are stricter.

The 7(a) is the most common SBA loan, and it has the widest range of applications. The majority of SBA 7(a) loans are given to established businesses to shore up their operating capital, but they can also be used by newer enterprises for purchasing commercial real estate. The maximum amount for this kind of loan ranges as high  as 85% to 90% of the purchase price, up to $5 million, with a down payment equaling 10% to 15%. Interest rates are within the 5% to 8.5% range.

An SBA 7(a) loan requires a credit score of 680 or higher and three years of business history, and the repayment term is typically 10 to 25 years. Also note that these loans aren’t made by the Small Business Administration itself but by SBA-approved lenders, which can be traditional banks, credit unions, or private lenders. With potential borrowers following the SBA’s guidelines, those lenders have more faith that loans made to “riskier” parties will be repaid and are therefore more inclined to grant them.

Designed specifically for the purchase of commercial real estate properties, a CDC/SBA 504 is like two loans in one: 50% of the money comes from a bank or lender, 40% from a local community development corporation (CDC), and the remaining 10% being the borrower’s down payment. There is no maximum amount you can borrow on a CDC/SBA 504 loan.

The CDC/SBA 504, like all Small Business Administration loans, is backed by the government and requires a 680 or higher credit score but differs in that the borrower also must meet the local CDC’s public policy and job creation goals. The SBA doesn’t monitor the rates, fees, and terms of the lender’s portion of the loan, but it does establish the CDC’s, setting 10-year loans at 4.85% fixed interest or 20-year loans at 5.07% fixed interest.

Interest rates for CDC/SBA 504 loans fall between 3.5% and 5%, with a 1.5% CDC processing fee. Since this SBA loan was crafted to spur local community development and employment, a qualifying company is also expected to retain or create one job for every $65,000 borrowed. If your business is projected to grow quickly but you don’t have much down payment cash on hand for a new real estate space, a CDC/SBA 504 loan might be a better option than a more broadly defined loan.

Lenders look at five factors: your personal credit score (which should be at least 600), your net worth (the difference between your liabilities and your assets), your liquidity (how much liquid cash you have on hand), your business experience (as it applies to the real estate you’re financing), and your income (both your personal and commercial property portfolios).

Commercial real estate loan repayment terms are shorter than those of the average 30-year residential loan. In most cases, longer repayment schedules result in higher interest rates, but shorter terms with smaller payments could leave you stuck with a balloon payment (a disproportionately large lump sum of money required to complete repayment) at the end of the term.

For a traditional commercial mortgage, the minimum down payment varies between 15% and 35% of the overall purchase price, depending on the lender. With SBA 7(a) and CDC/SBA 504 loans, the range is more standardized, falling between 10% and 15% of the purchase price.

If you as a borrower attempt to pay down your loan ahead of the preset term schedule, you may incur a prepayment penalty fee. Lenders prefer to make their profits on the timeline they’ve set; early payment can result in a yield loss for them, so prepayment penalties are enforced to recoup the shortfall.

Should your loan go into default with a non-recourse loan, the lender can collect on the loan only by selling the real estate itself in a foreclosure sale; the borrower’s personal assets aren’t on the table. As they carry more risk for the lender, non-recourse loans aren’t the norm, and they come with more inflexible conditions and longer loan terms.

As with any type of loan, you’ll want to shop around to find the best commercial real estate lender to work with your small business. Traditional mortgage lenders should be your initial starting point, since the Small Business Administration won’t even talk to you about an SBA loan until you’ve first been turned down directly by a bank. Get all of your paperwork in order, review your personal credit score (despite what you may have heard, checking your own score does nothing to lower it), and start comparing lenders. If you’re paying cash for a car wash business, however, we’ll just look the other way.