What is Commercial Real Estate Lending?
Commercial real estate lending provides mortgage loans or other types of financing to companies to buy properties used for business purposes. Commercial real estate includes housing (such as hotels, apartment buildings, condominiums, and housing developments); office buildings; retail sales buildings (such as shopping centers and malls); warehouse, storage, and manufacturing facilities; hospitals and other medical facilities; restaurants; recreation parks; and raw land.
- Commercial real estate lending is the financing provided for companies to purchase business-related properties.
- Commercial real estate loans are usually secured loans, with the property being purchased serving as collateral.
- Because the large size of most commercial real estate loans poses a greater risk for the lender, larger down payments are required compared to residential mortgage loans.
Importance of Commercial Real Estate Loans
Commercial real estate loans are a critical part of the economy for a couple of major reasons.
- First, they are usually essential financing for nearly all businesses to be able to operate.
- Second, because commercial real estate loans are typically much larger than residential real estate loans, they provide the bulk of income earned for commercial banks and other lenders that provide them.
Although foundationally quite similar to residential real estate loans – loans for the purchase of property commonly secured by the property itself – commercial real estate lending encompasses a much wider array of loan types and is provided by a wider variety of types of lenders.
Commercial real estate loans may be sought for various purposes. A company may be seeking to purchase office, warehouse, or manufacturing space; a business may look for financing to acquire rental property; a housing development company may need a real estate loan to fund a new development project.
To learn more about the core concepts of commercial real estate lending, check out CFI’s Real Estate Fundamentals Course.
Types of Commercial Real Estate Loans
While there are dozens of specific financing structures that may be utilized in commercial real estate lending, broadly speaking, there are five major categories of commercial loans for real estate purchases – ordinary commercial real estate loans, seller-financed loans, bridge loans, loans obtained through the Small Business Administration (SBA), and hard money loans.
1. Ordinary commercial real estate loans
Ordinary commercial real estate financing closely resembles residential mortgage financing. The commercial loans are sometimes referred to as “permanent” loans. As with typical residential mortgage loans, the property being purchased usually serves as the loan collateral.
However, companies can secure a commercial real estate loan with other forms of collateral – such as equipment, inventory, other property the company already owns, or even a deposit account of some kind.
2. Seller-financed loans
Just as is the case with residential mortgage loans, a business looking to buy a commercial property may be able to obtain financing directly from the seller. When available, seller-provided financing is usually preferred over conventional commercial bank financing, as payment terms are often more flexible, and the buyer may also be able to get a lower interest rate.
Seller-financed loans are more commonly available for the purchase of income-producing properties, such as an apartment complex or when a company is purchasing a property from an individual rather than from another company.
3. Bridge loans
Bridge loans refer to short-term commercial real estate loans. The loan term for a bridge loan is usually somewhere in the range of six months to two years. Bridge loans are commonly used for one of two purposes – either the buyer expects to sell the property within the time frame of the bridge loan or they expect to be able to significantly improve their credit rating during that time frame.
Bridge loans are frequently used by commercial developers who, for example, expect to complete construction of an office building on purchased land, which they will then sell to another party. They are also used by real estate investors who purchase residential properties and “flip” them within a narrow time frame.
4. SBA loans
In the United States, small businesses may be able to get an SBA loan, which offers several advantages. When the SBA guarantees at least a portion of a commercial real estate loan, the borrower can usually get a substantially more favorable interest rate since the lender has much lower risk exposure.
Also, SBA loan funds can be used not just for property purchases but also for working capital, debt restructuring, buying machinery, purchasing inventory, and other purposes. The SBA loan program that offers the most flexibility for borrowers is the SBA 7(a) loan program. The other primary SBA loan program is SBA 504.
5. Hard money loans
Hard money commercial loans are offered by private investors or private lending companies. The loans are strictly guaranteed by the value of the property the money is loaned against. Hard money loans are commonly offered to companies with less than stellar credit – such that they may find it difficult to obtain a loan from a commercial bank, credit union, or other traditional lenders – or companies that may be experiencing some financial trouble.
Most hard money loans are for very short terms, often one year or less. In that respect, they resemble bridge loans. For example, a hard money loan may be made to help a company handle cash flow or debt service problems by taking out a loan secured by some property the company owns free and clear.
Other Sources for Commercial Real Estate Lending
In addition to commercial banks, credit unions, the SBA, private investors, and private companies that act as hard money lenders, other potential sources for commercial real estate lending include life insurance companies and crowdfunding.
1. Insurance companies
Life insurance companies look for solid, low-risk investments that offer better returns than “risk-free” investments such as Treasury bonds. One avenue of investing they often pursue is earning returns from making commercial real estate loans to financially sound development companies with excellent credit ratings.
Crowdfunding, or online peer-to-peer investing, is a growing source of commercial real estate lending. Websites – such as sharestates.com – connect private and institutional investors with companies seeking funds for real estate development.
Investors can specify their particular areas of interest, both in terms of geography and project types. Crowdfunded real estate investment trusts (REITs) are also growing in popularity.
CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
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