commercial property loans

Commercial Real Estate Loans 101: Everything You Need to Know

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You’re driving home from work one day and you see it!

A FOR SALE sign is posted in front of that busy strip mall. You know the one with popular retails stores and a parking lot full of cars. You notice the phrase Short Sale dangling from the bottom of the for sale sign.

Have you finally found that gem of an investment opportunity? When the average return on investment for commercial real estate is 9.5 percent, it’s certainly worth finding out!

If you think this might be your gem, you’ll need to learn about commercial property loans. Keep reading to get some commercial real estate lending basics.

What Is a Commercial Real Estate Loan?

A commercial real estate loan is a mortgage on a commercial property. A commercial property loan can be used for acquisition, development or construction.

Commercial property is income-producing real estate that is used solely for business purposes, such as:

  • Office buildings
  • Strip malls
  • Warehouses
  • Industrial plants
  • Malls
  • Medical centers
  • Hotels
  • Farmland
  • Apartment buildings
  • Garages

Unless you have the cash to pay the full purchase price of a commercial property, you’ll need to secure financing. How hard could that be? After all, you have a residential mortgage. Isn’t it fair to assume a commercial mortgage wouldn’t be much different?

This assumption would be a rookie mistake for first-time commercial real estate investors! Both types of mortgages are collateralized with real estate, but the similarities end there. Let’s take a look at the differences.

If you’re looking for commercial real estate opportunities in orange county, click here. 

How Are Commercial Property Loans Different from Residential Property Loans?

The best way to understand the differences between commercial mortgages and residential mortgages is to put yourself in the shoes of the lender. In short, commercial mortgages are perceived as riskier investments than residential mortgages. Here are a few reasons for the perception of higher risk:

Your priorities. If you’re in the position to be purchasing commercial property, you most likely own your own home. When a lender reviews all of the debt obligations of a borrower, they think about which obligations a borrower prioritizes if their ability to pay all their bills were to become limited. Lenders know that a borrower will prioritize payment of their residential mortgage over their commercial property mortgage.

Secondary market option. When you signed your residential mortgage loan agreement, you probably agreed to allow your mortgage to be sold in the secondary market. Fannie Mae, Freddie Mac or the Federal Housing Authority (FHA) can buy your mortgage from your lender. When this happens, your lender is no longer carrying the risk that you won’t pay the loan.

On the other hand, commercial property loans are rarely sold in the secondary market, so lenders keep these mortgages on their books. In other words, your lender maintains the risk that you will not pay back to loan. The lender will only grant commercial real estate loans to borrowers that they are confident will pay off the mortgage as agreed.

Source of repayment. When you applied for your home loan, you were asked to show proof of income. Based on that proof, the lender knew how you were going to pay the mortgage payment. It’s a little more complicated for a commercial real estate loan.

The source of repayment for a commercial real estate loan is often from tenant leases. For example, if you purchase a strip mall, you may have 6 tenants with leases that expire at different times. This is a risk to the property’s cash flow, the source of repayment to the lender.

Rate and term. Commercial property loans are their higher interest rates and much shorter repayment schedules. This higher rates and shorter terms are directly related to the lender’s risk assessment.

Do You Qualify for Commercial Real Estate Loans?

As you may have guessed based on our discussion above, it’s more difficult to qualify for commercial property loans than residential real estate loans. It’s a rigorous application and due diligence process.

Lenders have different criteria to determine who is a qualified borrower. In addition, lenders adapt their lending criteria based on market conditions. But all lenders will evaluate you based on some combination of the following five factors.

Character. A minimum credit score of 680 showing a track record of repaying debts as agreed, including a credit history without tax liens, foreclosures or recent bankruptcies.

Capacity. A positive net operating income on the property and at least a 1.25x debt service coverage ratio.

Capital. Equity injection of 20 to 35 percent of the property’s purchase price.

Collateral. Different types of real estate have different levels of risk for lenders. This impacts the assigned loan-to-value which can be anywhere between 50 and 90 percent.

A single purpose property, like a church, has a lower loan-to-value than a flexible purpose property, like an office building. If the collateral is owner-occupied, this will increase the loan-to-value.

Conditions. Choosing a commercial property in the right place and at the right time are important considerations. Lenders know you can’t necessarily control the economy or industry but you can research and be prepared to address any weaknesses in market conditions.

How Do You Apply for Commercial Real Estate Financing?

You understand by now that lenders have high expectations of commercial property loan applicants. Read below for a few tips on preparing for a smooth application process.

Research lenders. There are thousands of commercial real estate lenders. Some lenders focus on small loans, some on large; and some only lend against certain property types. You need to research lenders to identify where you’ll have the strongest possibility of qualifying.

Gather documents. Lenders’ requirements vary. Are you an individual applying for your first commercial real estate loan? Are you an experienced commercial real estate investor? At a minimum, the lender will need to see the following:

  • 3 most recent years personal tax returns and a personal financial statement
  • 3 most recent years of business tax returns and financial statements
  • 3 most recent months of bank statements
  • Property lease(s)
  • Property rent roll (if not 100% owner-occupied)
  • Property Income and expenses
  • Evidence of cash-on-hand for your down payment

If you’re a first-time applicant for a commercial property loan, you should be prepared with a business plan demonstrating your ability to manage commercial property.

Submit application. Consider applying to multiple lenders to increase your chances of approval. If you receive more than one approval, you’ll have some negotiating leverage with your lenders.

Be patient. Loans for commercial real estate take longer to close. Some lenders may promise less than 2 months but expect up to 6 months to close on a commercial property.

Review the loan agreement. Commercial property loans are often structured with a 3- to 5-year term and a 15- to 20-year amortization schedule. This means that you’ll have a large balloon payment at the end of the loan’s term. Do you have a plan in place to make the pay-off?

You Owe It to Yourself

Now that you understand the basics of commercial property loans, find out what type of investment in real estate you want. Maybe you want to learn more about that short sale of the strip mall.

Whatever type of commercial property you decide to buy, this guide has prepared you to put your best foot forward with lenders.

5 Reasons a Short Sale is Your Best Option

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Often people hear about the concept of a short sale and think it means the homeowner is in default on their loan. But that’s not always the case. Default is not necessary with every short sale. And not every short sale is caused by foreclosure.

Short sales occur when a bank decides to take a lower payoff than the overall balance of the loan. The amount of the mortgage is not a crucial component. What’s significant is your home’s price and market value. If your house is worth more than the mortgage, you may do a short sale.

This can be done as long as the net profit is below your loan’s total balance.

Despite common beliefs, your house doesn’t have to be underwater or upside down to do a short sale. An “underwater mortgage” is a home loan that has a greater principle than the value of the house on a free market.

It’s the bank’s net proceeds that determine if the house can be a short sale. If the sale’s net income is less than the outstanding balance owed on the loan, that home will be a short sale. This can happen even if the property is worth more than just the mortgage.

Here are 5 reasons why a short sale can be your best option:

1. You Can Short Sale Without Defaulting

 While many short sales involve a residence in foreclosure, a pending foreclosure doesn’t always mean a short sale.

To prevent making mortgage payments, not every bank needs a short sale. Some people can actually qualify for a short sale without being in financial difficulty.

With banks, just the chance of a default on a loan can qualify the seller for a short sale. The seller doesn’t always need to be behind on the loan.

If a seller can initiate a short sale without reporting late payments on a loan, this can lead to a stronger FICO score for that seller, rather than the alternative ding to one’s credit.

2. You Can Stop Worrying about Foreclosure

 There are numerous reasons why a borrower may not be able to make mortgage payments.  Financial hardships and unforeseen life events are completely understandable.  “Expect the unexpected,” right?

When you fail to make your mortgage payments for anywhere between 3 to 6 months, the failure to pay is usually met with a notice of loan default.

If the borrower wants to try and stop the home from going into foreclosure, they can attempt to enter a settlement of the debt with the lending bank. This settlement is what’s done in the form of a short sale of the home.

3. You Can Save Your Credit Score

 From an individual credit score perspective, a short sale is extremely preferential, particularly when judged against the possibility of foreclosure.

Credit scoring companies take a dark perspective on foreclosures and will file a lower credit score than to someone who carefully examined their options and decided to go with a short sale as the alternative.

Not only does it protect a person’s credit score, but it also keeps them in the playing field and allows for an easier home buying process in the future.

4. You Can Preserve Your Future of Home Buying

In many cases, the largest financial moment in an individual’s life is buying a home and taking on a mortgage. Preventing the worst case of a foreclosure, a home seller can more easily justify a short sale, such as deciding to move elsewhere for example.

On the flip side, buying a home after a foreclosure, and the resulting destruction of a person’s credit will be nothing less than a nightmare and a half!

5. You Can Avoid the Sales Fees

 

With the traditional sale of a house, the seller carries the strain of payments and fees. This includes paying commission rates to employed real estate agents.

These real estate agent fees can generally cost the seller up to six percent of the final sale of the house. But with a short sale, these fees and commissions are paid to the agents by the bank.  Direct savings for the seller!

Short Sales: Summarized

Typically, an interested buyer will make an offer that meets the values of the property. But often a seller is not in the position to accept such an offer, because the bank is the deciding factor.

In these instances, the lender must approve such offers since they are lower than what is owed on the home loan itself. The seller would then complete an application for a short sale along with the supporting information to be submitted to the lender.

This supporting information may include a letter indicating the seller’s hardship and the reasons for the inability to pay back the difference of the potential offer from the buyer.

Often, proof of income, as well as tax returns, are needed to show evidence of the hardship. An appraisal of the home will be done, and if it ends up reflecting a home value that matches the offer from the potential buyer, the bank may choose to accept it.

 

Other Considerations for Your Short Sale

Remember, this is not a quick or easy process.  It usually takes several months to go from start to finish. To make up for its financial loss, the bank will often require that the home buyer pays for the closing costs of the home as well as repairs.

Once your short sale is complete, the debt is settled, and you are free from the debt and payment. To sum it all up, a short sale is much better for your credit score and your future than a foreclosure is. So, remember, your best bet may very well be a short sale.

bank short sale

How to Get the Best Deal When Negotiating a Short Sale

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Within the first six months of 2018, over 300,000 United States properties either faced default notices, bank repossessions, or the Auction Block. If you’re facing financial troubles and selling your home at a loss may be your only option, it’s important to know how to go about a bank short sale and what it will involve.

If it’s time to move on from your home, read on for more information on approaching the bank with a short sale and how to get the most out of it.

What is a Bank Short Sale?

Whether you are looking to get out of financial trouble, or simply need to move on from your home when the market is less than ideal, you may be looking at a potential short sale.

At it’s most basic definition a short sale is when a homeowner sells their home for less than they originally paid. Meaning your home is now at a loss, or that you’re falling “short” on your investment.

While short sales are becoming less common due to a gradually improving economy, many individuals still face the prospect of having to sell their home for less than desired.

How Does a Short Sale Work

Your typical short sale situation will look something like this: Initially, a home seller will put their property on the real estate market, offering a short sale or subject lender deal to those that may be interested in buying.

Since short sale deals dramatically benefit the buyer, it won’t be long before the first offer will come in.

From there, the homeowner is responsible for contacting their bank to submit a formal application requesting the authorization of the short sale.

It’s important to note that there’s no direct guarantee that the bank will, in fact, approve the short sale. Once the bank has reviewed the pending application, there’s a good chance they will send out an appraiser to review the full value of the house and to be sure that it’s aligned with the current sales offer.

How a Short Sale can Benefit You

While a short sale may sound less than ideal, there are still a number of benefits that come with the solution.

For example, a short sale is a better alternative than a foreclosure when it comes to your credit score. It’s also emotionally easier to face the problem head-on than to stand under the pending doom of a potential foreclosure.

Finally, with a short sale, you won’t have to pay additional home sale fees. Typically real estate agent will take home 3% to 6% commissions on a home sale. The short sales are handled by the bank, so any additional fees and commissions are then covered by the bank.

How to Present a Short Sale Offer to Your Bank

As mentioned, there’s no guarantee that your bank will approve your offer for a short sale. However, you’ll find there are some steps you can take to enhance the likelihood of approval.

Part of the request for a short sale is that the short sale Bank will request your authorization for third-party. This means that third-party would have access to your personal information, something most individuals want to avoid.

However, it’s important to know that without the approval for the authorization you will be looking at slimmer chances of your application being approved.

Choosing the Right Short Sale Bank

Another way to increase the likelihood of having the application approved is by choosing a short sale bank with a reputation for approval.

This may mean looking into public records for previous property sales to see exactly which banks take on the most short sales in your area.

Bring in a Backup Offer

If you can come to the bank with more than one offer pending on the property this is a great way to show the bank that your short sale is a wise investment choice for them.

This will provide the bank with some security in case your current potential buyer falls through. The bank knows it will not be left with the house on their hands.

Why a Bank May Reject Your Short Sale Offer

In some cases, a bank may flat out say no to your short sale offer. This can be due to a number of reasons that in some cases can be adjusted for a secondary application.

These reasons often include a short sale list price that seems too high, a poor short sale definition, an incomplete short sale package, or that the seller or buyer simply does not qualify.

In some cases, it may already be that the bank has sold your loan and no longer is the one to be negotiating with.  In this case, the bank has no say as to what can and cannot be approved in terms of the loan.

Educating Yourself on Short Loans

The best thing you can do when presenting an offer to a bank is to have as much information to back you as possible. Spend some time doing the necessary research to increase your results of a solid bank short sale transaction.

If you’re looking for more information on what to expect from your short sale, check out our Blog on 7 things you never knew about the short sale process.

You’ll find that these tips and information can be incredibly useful when it’s time to put your house on the market or to submit your application to the bank.