Did you know that small businesses employ over 50% of the working population in the U.S.?
Small business is the beating heart of the American economy, and commercial real estate is at the center of many small business ventures.
Starting a small business is not easy, especially if you are trying to get a commercial real estate loan.
Here is your ultimate guide to the ins and outs of commercial real estate financing.
Types of Commercial Real Estate Financing
There are two types of commercial real estate mortgage (CREM): Traditional and Small Business Administration (SBA). We will take a look at both options here.
Traditional CREM Financing
Traditional commercial property loans are loans from a bank or an investor.
A word of warning, a commercial loan is different than a consumer loan. With a consumer real estate loan, you will finance long-term for a low rate.
For example, when you buy a home, you are eligible for 30-year financing at a low, fixed rate. That is not the case with a traditional CREM.
Bank rates vary depending on the national cost of funds. The higher the risk to the bank, the higher your rate is.
Small businesses, especially new businesses, are risky. Your rate is likely higher than a traditional home loan.
Also, traditional commercial real estate financing is usually capped at 20 years. Again, this is due to the riskier nature of commercial real estate loans.
The Small Business Administration is a government agency whose main purpose is to help small businesses get access to loans.
Note, you still need to go through a lending source, like a bank or broker, to get an SBA loan. The good news is that there are many advantages to SBA financing, both for you and your lender.
SBA loans often have lower down payments and longer repayment terms. They offer the bank a government guarantee, meaning they can offer lower rates with less risk.
Two types of SBA financing apply to commercial real estate financing, known as an SBA 504 loan and an SBA 7(a) loan. Your lender can discuss the options with you and determine which is best for your business.
Information You’ll Need to Provide
Your lender needs certain information from you to make a credit decision. The amount of information depends on the amount of money you need.
For most CREMs, you will provide the lender with the following information beforehand:
- Tax returns–3 years for both you and your business.
- If your business is new, a business plan with cash flow projections.
- A personal financial statement detailing your assets and liabilities.
- Cash flow projections, including income, expenses, and net profit.
Once you provide this information, your lender determines what loan product is best for you.
What Does the Bank Look At?
Debt service coverage ratio (DSCR) and loan to value ratio (LTV) are the two most important ratios your lender will use to determine your eligibility. Let’s take a look at each now.
DSCR is a profitability ratio. Take your net income and divide it by your loan obligations. Here is an example:
Your business had $12,000 in net income last year (that’s gross sales minus expenses). Your mortgage payments totaled $10,000. Your DSCR is $12,000 / $10,000 = 1.20.
Banks want to see a DSCR of 1.20 or higher to consider a loan. It is important to remember this when you create your business projections. Factor in the new debt and figure your DSCR.
LTV is the ratio of your loan to the value of the property. For example, you request a loan of $80,000 to buy a building that is worth $100,000. LTV is $80,000 / $100,000 = 80%.
Banks consider a low LTV to be less risky. That means the more money you can put into the purchase, the better your loan terms.
Are You Ready?
Commercial real estate financing does not have to be difficult. If you are in the market for the perfect investment property, we have got the products you need to pay for it.
Check out our blog for more helpful articles related to small business financing.
Penn Commercial Capital can help you secure your next round of financing or business loan in an efficient and ethical manner. We’re proud to champion the small businessperson and can finance clients seeking loans from as little as $100,000 up to $100 million.