Financing Commercial Property

Financing commercial properties and residential investment properties are very similar.

OVERVIEW

The risk of payment default for the lender is higher on commercial property held for investment purposes rather than owner occupied commercial property. As a business owner operating out of that property you will have a much stronger incentive to make payments so that your business has a place to operate. The greater risk results in higher interest rates than for a primary residence.

INTEREST RATES AND TERMS

Fixed interest rates are available, but generally not for more than 5 years. Many lender will not commit to a loan term of more than five years. This will require you to refinance your commercial mortgage in 5 years. The term for this is a “balloon” loan.

There are some lenders that will offer a fixed rate for two to five years with a loan term of ten to twenty years. The longer term commitment eliminates both the cost and risks of refinancing. In the current market many lenders have substantial commercial real estate portfolios where property values have declined 50% or more. Clearly another lender isn’t interested in stepping in and refinancing an outstanding loan balance that is significantly higher than the existing fair market value of the property. This is why is it worthwhile to pay a slightly higher rate for the guarantee of a long repayment period.
So what does the underwriter look at to approve the loan?

I. Your credit – You need to have paid your other financial obligations as agreed. This usually means a middle credit score of at least 660.

II. Your experience as a commercial property investor –

a) Lenders generally look for at least 2 years of “property management” experience. If you haven’t filed a Schedule E, you will be considered a “first time” investor.
b) A “first time” investor must have enough income to cover the entire PITI for the subject rental
property with no credit for any income received.

III) The loan application process – The application process is complicated and takes longer than buying a home.

a) It is a TEAM EFFORT – you need a realtor and lender who understand the commercial property market.
b) Closing timeframes 60 days or more.
c) Appraisal costs are substantially higher because the lender requires an appraisal that compares rental income from similar properties that have recently sold. The appraiser must also include an analysis of the operating costs for the property.
d) Be prepared to put up a minimum of 25 - 30% equity.

IV. Lenders will require at least six months of cash reserves. Cash balances in checking, savings and money market accounts are all considered cash.

V. Analyzing cash flow from a property – Several methods exist to analyze cash flows, but ultimately the one that will determine your loan approval is how the lender looks at cash flow. The following chart outlines differences in the methods. Because the lenders have the money, their analysis is the one that counts.

Analyzing Cash Flow - Lender vs. Your View