Commercial Real Estate Loans

A Commercial Real Estate Loan is a mortgage secured by commercial property (5+ unit apartments, office buildings, retail centers, industrial properties, etc.) rather than residential property. These loans are primarily underwritten based on the property's income-generating potential rather than the borrower's personal income. Commercial loans typically have different terms, rates, and requirements than residential mortgages, including shorter terms (5-25 years), balloon payments, and higher interest rates.

Commercial loans finance income-producing properties including: 1) Multi-family buildings (5+ units), 2) Office buildings, 3) Retail centers and shopping malls, 4) Industrial properties (warehouses, manufacturing), 5) Hotels and hospitality properties, 6) Medical offices and facilities, 7) Self-storage facilities, 8) Mixed-use properties, and 9) Special purpose properties. Single-family homes, 2-4 unit residential properties, and owner-occupied residential properties typically qualify for residential financing instead.

The minimum loan amount varies by lender but typically starts at $500,000 for commercial real estate loans. Some lenders may consider smaller loans (starting at $250,000) for certain property types or experienced borrowers. Maximum loan amounts can reach $10,000,000+ through portfolio lending or can be structured through commercial mortgage-backed securities (CMBS) or agency programs (Fannie Mae/Freddie Mac for multi-family) for larger transactions.

Commercial loans differ from residential mortgages in several key ways: 1) Underwriting focuses on property cash flow (DSCR) rather than personal income, 2) Terms are shorter (typically 5-25 years vs 30 years), 3) Most have balloon payments at maturity, 4) Rates are higher (typically 1-3% above residential rates), 5) Personal guarantees are almost always required, 6) Environmental assessments are standard, 7) Loan documentation is more complex, and 8) Closing takes longer (60-90 days vs 30-45 days).

Debt Service Coverage Ratio (DSCR) is the primary underwriting metric for commercial loans. It measures the property's ability to cover its debt payments: DSCR = Net Operating Income (NOI) ÷ Annual Debt Service. A DSCR of 1.25 means the property generates 25% more income than needed to cover its debt payments. Most lenders require minimum DSCR of 1.20-1.35. Higher DSCR indicates lower risk and may qualify for better terms. DSCR is calculated using property financials, not borrower income.

Commercial loan applications require extensive documentation including: 1) Property financial statements (2-3 years), 2) Current rent roll and leases, 3) Operating statements (Trailing 12 months), 4) Property tax bills, 5) Insurance certificates, 6) Borrower personal/business tax returns (2-3 years), 7) Personal financial statements, 8) Business entity documents (articles, operating agreements), 9) Purchase agreement (for acquisitions), and 10) Property plans/specs (for construction). Additional documents may be requested during underwriting.

Yes, personal guarantees are almost always required for commercial real estate loans, even when borrowing through a business entity. Lenders typically require unlimited personal guarantees from all principals with 20%+ ownership. Some lenders may accept springing guarantees (only trigger upon default) or partial guarantees for very strong properties/borrowers. Corporate guarantees from parent companies may also be required. The purpose is to ensure borrower commitment and provide additional recourse beyond the property collateral.

The commercial loan process typically takes 60-90 days from application to closing, which is longer than residential mortgages due to additional complexities: 1) Property due diligence (appraisal, environmental, engineering), 2) Complex underwriting analysis, 3) Third-party report coordination, 4) Title/survey review, 5) Legal documentation preparation, and 6) Multiple stakeholder coordination. Construction loans may take 90-120+ days. Starting with complete, organized documents can significantly speed up the process.

Commercial loans typically require several third-party reports: 1) MAI appraisal (most expensive but most comprehensive), 2) Phase I Environmental Site Assessment (ESA), 3) Property Condition Assessment (PCA) or engineering report, 4) ALTA/ACSM survey, 5) Seismic reports (in certain areas), 6) Zoning reports, and 7) Property-specific reports (asbestos, lead, mold if indicated). The borrower typically pays for these reports, which can cost $10,000-$50,000+ depending on property size and complexity.

Commercial loan closing costs typically range from 2-5% of the loan amount and include: 1) Lender fees (origination, underwriting, processing), 2) Third-party report fees (appraisal, environmental, engineering), 3) Legal fees (lender and borrower counsel), 4) Title insurance and recording fees, 5) Survey costs, 6) Prepaid items (interest, insurance, taxes), and 7) Escrow/reserve funding. Additional costs may include: brokerage commissions, consulting fees, and property-specific due diligence. Larger loans generally have lower percentage costs.

Commercial loan interest rates vary widely based on: 1) Property type and quality, 2) Loan size, 3) Loan-to-value ratio, 4) Debt service coverage ratio, 5) Borrower experience/credit, 6) Market conditions, and 7) Loan program. As of 2024, rates typically range from: Prime multi-family (agency): 5.5-7.5%, Core commercial: 6.5-8.5%, Value-add/bridge: 8.5-12%, Construction: 8-12%. Rates are typically 1-3% higher than comparable residential rates due to higher perceived risk and shorter terms.

Commercial loan LTV ratios typically range from 65-80% depending on property type and loan program: 1) Multi-family (agency): 75-80% LTV, 2) Office/retail: 65-75% LTV, 3) Industrial: 70-75% LTV, 4) Construction: 75-85% LTC (loan-to-cost), 5) Bridge loans: 70-75% LTV, 6) Special purpose properties: 50-65% LTV. Higher LTVs usually come with higher interest rates and stricter DSCR requirements. Cash-out refinances typically max at 70-75% LTV.

Yes, most commercial loans have prepayment penalties to protect the lender's yield. Common structures include: 1) Yield maintenance (makes lender whole for lost interest), 2) Defeasance (substitute Treasury securities for loan payments), 3) Lockout periods (no prepayment allowed for 1-5 years), 4) Step-down penalties (decreasing percentage over time, e.g., 5-4-3-2-1%), and 5) Flat percentage (e.g., 2-5% of loan balance). Some short-term/bridge loans may have simpler penalties or none at all. Always review prepayment terms carefully.

Beyond loan payments, commercial property owners should budget for: 1) Property taxes (typically 1-3% of value annually), 2) Insurance (property, liability, umbrella), 3) Maintenance and repairs (1-2% of property value annually), 4) Property management fees (3-8% of collected rent), 5) Utilities (if not paid by tenants), 6) Capital expenditures (roof, HVAC, parking lot replacements), 7) Legal/accounting fees, 8) Marketing/vacancy costs, and 9) Reserve requirements (often required by lenders). Proper budgeting is critical for maintaining DSCR.