Real estate is one resource that only increases in value over time and investing in real estate properties can be a great way to generate a passive income. Commercial properties, in particular, are more lucrative than residential properties because they offer enhanced benefits such as providing a higher potential for income and increased appreciation value.

However, one major downside is that it requires a larger initial investment compared to residential properties. The good news is that Clopton Capital offers commercial real estate loans that will help finance your venture.

To further understand how commercial real estate loans work, highlighted below are the fundamentals of these loans for investors.

What Is a Commercial Real Estate Loan

A commercial real estate loan is a type of loan that allows investors to purchase investment properties, specifically commercial ones. An example of a commercial property is a building that is used as an office space or for retail.

There are various types of commercial real estate loans that help investors everywhere purchase commercial properties with easier and more convenient payment terms.

Difference From Other Loans

Commercial real estate loans often have shorter payment terms compared to standard mortgages, with terms usually ranging between 5 to 20 years compared to the standard 15 to 30 years.

Moreover, the downpayment required is slightly higher than that of standard loans, usually somewhere around 25 to 30% of the total amount. SBA loans are the exceptions to this by requiring only around 10 to 15% for those qualified.

How Do Commercial Real Estate Loans Work

Unlike with residential loans, commercial real estate loans are loans that specifically finance income-generating properties. An investor who wants to borrow money for commercial property often needs to establish a business entity to qualify for this type of loan.

Lenders also often require the borrower to put the property as collateral so they can seize the property in the event they default on their payments. Moreover, aside from having a good credit score, another important requirement when lenders decide whether or not to approve the loan is the property’s potential to generate income.

Commercial real estate loans are associated with higher risks but borrowers often have the incentive of the property’s potential income.

Most Common Financing Options for Commercial Real Estate

Here are some of the most common types of commercial real estate loans.

Small Business Administration / SBA 7(A) Loans

This loan option is backed by the US Small Business Administration and is perfect for smaller projects. This financing option is the easiest to apply for among all of the SBA loans. Moreover, this loan applies to those who want to buy or refinance commercial properties up to $5 million.

CDC / SBA 504 Loans

If you’re investing in a larger project, particularly costing more than $5 million, then this is the loan for you. However, this requires a downpayment of 10% of the entire amount while the remaining 40% and 50% are financed by an SBA certified development company and the lender respectively.

Traditional/Conventional Commercial Mortgages

This type of loan is offered by banks and institutionalized lenders. This is perfect if you have a great credit history and are working with medium- to large-scale projects. Payment terms often range from 5 to 20 years and most banks offer competitive rates for the interest. The only downside is that they require a 20% down and often charge penalty fees for early payment.

Commercial Bridge Loans

These loans are short-term loans that help commercial property investors secure financing immediately while searching for a long-term financing option. The required downpayment for this type of loan is usually around 10 to 20% of the loan to value.

Commercial Hard Money Loans

This type of loan often comes with higher interest rates but can be received immediately without the need for good credit history. This loan is perfect for those who need immediate financing with short-term payment terms.

Basic Requirements for Commercial Real Estate Loans

Your Credit History

Although a good credit score will add points to your favor, a more deciding factor is your credit history. Ensure that there are no recent bankruptcies or foreclosures in your history or else you’ll find yourself undergoing a difficult process for loan approval.

Low LTV (Loan-to-Value) Ratio

The LTV ratio is the amount of equity or collateral the borrower has with a given property. This can be calculated by dividing the entire amount by the purchase price of the property. Commercial property investors need a minimum LTV ratio in the 65 to 80% range.

Business Entity

A common mistake for many beginners in the commercial property investment industry. Having a business entity set up before applying for a loan can be a large factor in determining whether or not your application will be approved.

Commercial Real Estate Loan Interest Rates

Interest rates for commercial real estate loans vary and depends on the lending institution you’re borrowing from. SBA loans tend to have the lowest rates, usually ranging from 3.5 to 6.75% while hard money loans often have the highest rates, typically ranging from 10 to 18%. Conventional bank loans are somewhere in the middle, with interest rates being around the 5 to 7% range.

How Long Does It Take To Get a Commercial Real Estate Loan

There are various factors that affect the loan process and many would tell you that it will only take around 30 to 45 days. However, more accurate estimation is around 45 to 120 days. This means you may need to enter the process with a more flexible mindset.

Conclusion

Although it can come with a higher risk, investing in commercial properties is still a great way to earn a passive income. However, financing a commercial property can be more difficult than financing a residential one which is where commercial real estate loans come in.

They can help you finance your venture and some loans come with competitive terms for qualified buyers. One thing to remember is that this type of loan is more difficult to secure because of the amount needed to purchase a commercial property. Due diligence and preparation are needed in order to make the process go as smoothly as possible.

If you remain focused despite the challenges, then you might just find yourself with a great passive income-generating property.