Overview of the Various Types of Commercial Real Estate Loans

If you consider investing in commercial real estate, you will likely need to secure a loan. While loans for personal property are generally straightforward, you will need to be familiar with several different types of commercial real estate loans.

The commercial real estate loan structure can be a little daunting for those unfamiliar with them. This post will give you a basic overview of the most common types of commercial real estate loans.

Who Purchases Commercial Real Estate?

People may purchase a commercial property for an array of reasons. It may be bought by a small business seeking to expand its facilities from offices to warehousing. Individual or institutional investors often acquire commercial property simply as an investment or seasoned owners who purchase the property to rent out later and collect the income.

There are various types of commercial real estate loans available. Commercial real estate loans are designed to accommodate each kind of investor.

What Types of Commercial Real Estate Loans Are Available?

There are various types of commercial real estate loans available. Let’s look at each type:

Traditional Types of Commercial Loans

The most common types of loans for commercial real estate are the traditional model loans. This structure is similar to a loan used to purchase a single-family home that typically has a fixed rate over 30 years but often has a shorter term and a variable rate instead.

When using a traditional commercial real estate loan, you may be required to put up to 25% down on the property’s purchase price. The loan may last between 5 and 25 years but often lasts between 5 and 15 years.

Before a loan is issued, the bank will appraise the property. The lender will also want to see financial forecasts to determine whether the debt service can cover existing rates. Business owners interested in owning their office space and commercial real estate investors use traditional terms for commercial real estate loans.

Commercial Bridge Loans

A commercial bridge loan is a source of short-term capital that is often used for debt service until an owner improves, refinances, or otherwise completes a property transaction. It is short-term and usually has a higher interest rate than a traditional commercial real estate loan.

These commercial mortgages are often used to cover a balloon payment on a loan. The property is then refinanced under a conventional loan agreement. People may also use these loans for renovations on an existing property.

Commercial Hard Money Loans

A commercial hard money loan is secured using commercial real estate as collateral. These loans are provided by alternative lenders, such as individuals or non-bank companies. The approval process to obtain a commercial hard money loan is much faster since few underwriting regulations exist.

These commercial loans are usually issued much faster than traditional loans. A traditional loan may take 30 to 60 days to process, while a commercial hard money loan is often completed within a week. Due to the reduced regulation associated with these loans, people may use them for various purposes.

Hard money loans are typically one of the most expensive sources of financing for commercial real estate. They have interest rates between 10 and 20%.

SBA 7(a) Loans

An SBA 7(a) loan is the most common type of SBA loan. They’re used to help a business with working capital needs but may also be used to purchase or refinance owner-occupied commercial space at an amount up to $5 million.

To qualify for an SBA 7(a) loan, the business owner must have good credit and present a down payment of at least 10% of the property’s purchase price. The business must have been in existence for at least three years. The loan may be for up to 25 years, and interest rates are generally a reasonable 5 to 8.75%.

SBA 504 Loans

SBA 504 loans are similar to their 7(a) counterparts, but there is no limit to the borrowing amount. They typically require good credit and a down payment equal to 10% of the purchase price.

Loan terms are typically 20 years when used to purchase commercial real estate, and the business owner must occupy at least 51% of the property. Interest rates vary between 3.5% and 5%.

Commercial Mezzanine Loan

A commercial mezzanine loan is a second type of financing made on a property and secured by the owner’s equity in the real estate. It can be structured in various ways, including junior debt, preferred equity, convertible debt, or participating debt.

Junior Debt

This type of debt is typically used as a second source of capital, repaid after the senior loan is paid off in full. Borrowers may use it for acquisitions or further development of the property.

Preferred Equity

Under a preferred equity loan, property owners receive a fixed, preferential return paid ahead of distributions to the “common” equity interests in the deal. This type of loan is most commonly used in joint venture situations. In this case, the investors get a higher rate of return on their investment for being subordinate to the primary loan.

Convertible Debt

Borrowers may convert this type of debt into equity according to specific terms.

Participating Debt

Under a participating debt agreement, investors will receive interest payments and a share of the rental revenue generated on a property if it exceeds a certain amount. Participating debt is often used to finance commercial properties that have reliable tenants.

Regardless of the type of debt incurred under a mezzanine loan, the lenders will be secondary to the primary lender if the mortgage defaults. To account for the increased risk, the cost of mezzanine capital tends to be much higher than for a traditional loan.

Commercial Construction Loans

A commercial construction loan is a type of loan used to finance the costs associated with constructing or renovating a commercial building. Specific amounts are received under this type of loan as each new project milestone associated with building the property is met. The borrower makes interest payments on the amounts received.

Once the building is fully constructed, and the loan has been completely disbursed, payment in full will be due. Usually, borrowers take out a traditional commercial real estate loan to cover the construction loan amount. This approach will result in lower payments stretched over a longer period.

Take-Out Loan

A take-out loan is used to replace an older loan. For example, if an investor used a construction loan to build a new property, they could use a take-out loan to replace the construction loan once the property has been fully built. It would require smaller payments over a longer period.

In exchange for lower interest rates and smaller payments, the lender of a take-out loan might require that the borrower share a part of the rents earned from the property or a percentage of the gain acquired if the property is sold.

types of commercial real estate loans

Are You Looking for a Commercial Real Estate Loan?

Negotiationg with commercial real estate lenders to find the best fit for your project can be difficult and time-consuming. If you’d like to invest in commercial real estate and seek a loan, consider Finance Lobby. We match borrowers with lenders according to their borrowing needs. We’re transforming the CRE lending industry by making it easier than ever for brokers and lenders to find deals they can close on!

February 18, 2022

sign up for more insights