Commercial real estate lending is financing any income-generating real estate’s acquisition, development, and construction phases. It includes commercial spaces for lease to third parties and non-residential real estate occupied by its owners or a related party.
This financing option plays a vital role in the economy. First, it provides businesses with the necessary funds to acquire or enhance properties. Second, real estate financing triggers economic advancements while fostering employment opportunities.
Finally, commercial lending contributes to the stability of the real estate market, the progress of property development, and the enhancement of investments. The presence of diverse financing options plays a vital role in preserving an essential equilibrium between supply and demand in both the lending and commercial real estate domains.
But what are the commercial real estate lending guidelines? And what requirements do they entail? This article is a brief guide on the mechanics of the commercial real estate lending process and the potential benefits it offers to businesses.
Key Players in the Commercial Real Estate Lending Market
Various entities contribute to the real estate lending industry. It includes mortgage brokers, insurance companies, commercial banks, and more.
Commercial banks, being conventional lenders, offer loans to cater to various needs of institutions and individuals. Among the sectors they serve is the real estate industry. They have departments attending to commercial real estate lending platforms. Aside from that, they also provide multiple loan options to businesses.
On the other hand, insurance companies commonly use commercial real estate lending, utilizing their financial knowledge and assets to offer borrowers advantageous loan choices and favorable terms.
When businesses opt to secure a real estate loan, mortgage brokers become intermediaries connecting them with lenders. These brokers aid enterprises in maneuvering through the lending process, assembling necessary paperwork, and linking borrowers with the most suitable lenders.
In addition, non-bank lenders, including alternative financing sources and private lending institutions, have emerged as commercial real estate lending players. They offer innovative financing solutions and more lenient terms to their customers. On top of that, they also possess expertise in specific borrower profiles and certain property sectors.
For instance, some alternative financing entities focus on providing banking solutions to cannabis businesses. They ensure they comply with financial regulations whenever they take out a loan, file taxes, or wire payments domestically.
The Commercial Real Estate Lending Process
Real estate lending involves financing commercial property purchases, development, or construction. It’s akin to commercial cash-out refinance, wherein you loan money for your property.
These two concepts are different in that in commercial real estate lending, you’re obtaining a new loan using the investment property as collateral. In refinancing, you get a reloan from your property and extract equity.
When commercial real estate lenders shortlist a pool of clients, they analyze their business health, specific borrowing needs, and possible loan structure or terms. Once the team has secured the client’s commitment to continue with a formal credit application, the analysis and underwriting stage commences.
This process includes evaluating the property’s market potential and value, assessing the borrower’s financial statements and creditworthiness, and analyzing the risk associated with the loan. At this stage, the bank’s credit committee or adjudication team must provide the final approval of the proposed credit structure.
Once approved, both parties will finalize the documentation and loan terms. They execute the loan agreement, and the lender’s counsel correctly registers any liens against the business and its assets. This step officially leads to the loan’s closing and funding.
When both parties have completed all these steps, the loan is advanced, and the borrower gains access to the funds. Collaboration between the lender, borrower, and other relevant parties, including attorneys and appraisers, is essential throughout this procedure. It ensures a successful and smooth real estate lending experience.
Types of Commercial Real Estate Loans
Several types of commercial lending for real estate are available to businesses, tailored to meet various financing needs. Examples include owner-occupied and income-producing commercial mortgages, construction loans, and bridge loans.
Owner-occupied real estate loans
In owner-occupied commercial mortgages, the operating company with shared control or ownership of the physical property occupies the property. In this case, the operating company’s cash flow services the mortgage. Thus, the business’ overall indicators and financial health underwrite the credit.
Typically, borrowers amortize these loans over a span of 20 to 25 years. In addition, building and operating company expenses influence the debt service coverage ratio calculation to mitigate double-count occupancy costs.
Income-producing commercial mortgages
Meanwhile, borrowers are investors in income-producing commercial mortgages. They own property that a third-party entity or business occupies. In this loan, rental payments serve as loan obligations. Thus, lenders must know how to navigate rent rolls and lease terms.
Credit for this commercial mortgage is underwritten depending on the lease maturity profile and tenant quality. The loan is usually amortized between 15 and 25 years, depending on the property class.
For instance, a versatile property such as an office or warehouse requires extended amortization. Meanwhile, a specialized property like a golf course or self-storage involves more risks and tends to have a shorter amortization.
Construction loans
On the other hand, construction financing refers to a specialized type of real estate lending. Commercial real estate lending companies extend support for the development and redevelopment of establishments through loans in advance of realizing potential cash flow.
This loan is riskier than an amortizing commercial mortgage, characterized by predictable monthly payments. In this case, credit is advanced in stages or progress draws, depending on project milestones.
These loans do not involve cash interest payments throughout the contract. Upon project completion, the borrower repays the principal amount, including accrued interest.
Bridge loans
Lastly, bridge loans are usually a higher-risk type of real estate loan. It bridges the gap between more traditional types of credit.
For example, a developer completes a project for a cannabis dispensary, and the construction loan is due. However, the cannabis business has yet to take out a loan, so the commercial mortgage lender can’t advance funds.
At this point, the developer would need a bridge loan to finance the construction loan. At the same time, they wait for the cannabis business to occupy the space. It also ensures the commercial mortgage can advance and take effect.
This credit structure is “interest only” and tends to require higher fees and rates. Thus, most cash-flow lenders, such as credit unions and commercial banks, don’t practice bridge financing. However, non-bank or private equity lenders take this opportunity because of their high-risk tolerance for return on funds deployed.
Explore the Different Types of Commercial Loans Before You Apply
Getting approved for a loan is just a tiny part of the process. More than getting the loan proceeds, any lender must know the interest rates, payment terms, and other loan details. Diligence on the borrower’s part requires that you understand how and when to protect your rights and honor your obligations.
Through this, you could plan your finances. You won’t worry about hidden charges and can pay your debts smoothly. In the end, you still enjoy good credit standing.
