A Beginning Investor's Guide to Commercial Real Estate Loans

Is your real estate investment business outgrowing conventional loans? It may be time to explore commercial real estate loans as an option.

Commercial loans are more flexible than conventional loans. They can help you grow your residential portfolio much larger than most lenders allow. Plus, they can open the door to exciting investment types beyond single-family homes and condos.

In this article, we’re going to give you a crash course on commercial loans. We'll look at what they are, the pros and cons, and how to get one.

What Are Commercial Loans?

As the name implies, commercial loans are mortgages designed for commercial real estate. This includes properties like large apartment buildings, storefronts, offices, and hotels.

Commercial loans are also a good option for portfolios of residential properties. If, for example, a lender will not approve a conventional loan for a sixth income property, you could potentially buy the property with a commercial loan. You may even be able to refinance your individual properties into a single commercial portfolio loan.

How Are Commercial Loans Different From Residential Loans?

Commercial loans and residential loans are different in several notable ways:

• Home loans only cover residential properties of up to four units. Commercial loans cover commercial property types, which include residential properties of five or more units. Lenders also usually aren’t comfortable issuing residential loans for more than five to 10 properties for a single owner.
• Commercial loans are usually harder to qualify for than home loans. 
• Commercial loan terms are shorter than home loans. Repayment periods for commercial loans are typically 10–20 years rather than the traditional 15–30-year home mortgage.
• Interest rates are often higher with a commercial loan.
• Even though homeowners can get low down payment options for their primary residences, the minimum for an investment property is usually 15–20%. Commercial loan down payments typically range from 15–35%.

Pros and Cons of Commercial Loans

Commercial loans come with several benefits and disadvantages that any investor should consider.

Commercial Loan Pros

• They are flexible enough to cover a wide range of property types.
• The shorter repayment period means less time to accumulate interest expenses.
• You might be able to negotiate a down payment as low as 15%.

Commercial Loan Cons:

• They’re harder to qualify for than conventional home loans.
• The interest rates are typically higher than residential loans.
• The shorter repayment period means higher monthly payments. 
• Your lender could demand a higher down payment if they feel there is a higher risk.
• They often come with prepayment penalties.

How To Get a Commercial Loan

If you're ready to apply for a commercial loan, it's a straightforward process. Here's how you can apply it in five simple steps:

Step 1: Establish Your Goals

What type of property are you looking to buy? How long do you plan to hold it? Are you looking for the lowest possible interest rate? Or would you be willing to pay a higher rate for a lower down payment? What is your exit strategy? Getting clear on these goals will help you decide on a loan type and a lender.

Step 2: Determine Which Type of Commercial Loan Will Work Best for You

As with home loans, there are several types of commercial loans. You might look into:

• Small Business Administration (SBA) real estate loans
• Certified Development Company (CDC) loans through the SBA
• Commercial conventional loans
• Commercial bridge loans
• Hard money loans

Step 3: Find Your New Property

You can always work with a real estate agent to find properties on the open market. But, if you’re looking to score a great deal, you might want to search for off-market properties. Fewer buyers will be competing for these deals, so you have an advantage in negotiations. With real estate investment software like PropStream, you can locate distressed properties off the market and reach out to the owners directly. 

Step 4: Shop Lenders

Take the time to compare lenders to find the best interest rates and the best terms for your needs. You might want to look for a lender while you look at properties. This way it won’t hold up your deal. But, you don’t want to choose a lender too early because terms like interest rates could change.

Step 5. Gather Your Documents and Apply

As with any loan application, you’ll need to qualify based on factors like credit and income. Whether you’re going to apply as an individual or as a business entity, you’ll need to have your financial documents in order. Then you can apply for your loan.

Is a Commercial Loan Right for You?

If you’re looking to buy commercial real estate or grow your residential investment portfolio beyond five or 10 properties, a commercial loan may be the best option for you. Just consult with your accountant or financial planner to cement your financing strategy. And make sure to spend time shopping lenders to find the best rates and terms.