How to Get a Commercial Real Estate Loan: What Do Lenders Consider?

A commercial real estate loan is a loan for property used for commercial purposes and is one of the most lucrative investments someone can make. The building, an office space, an apartment building or a warehouse can be used as the collateral for the mortgage. So how does it work? What do lenders consider when you apply for the loan? We are answering those questions in this article, so you have all the information you need to decide what’s right for your business.

What is a Commercial Real Estate Loan?

A commercial real estate loan is designed for the purpose of purchasing new or existing commercial properties or renovating a commercial space. There are various loan options with their own unique set of eligibility requirements, rates, terms, loan amounts, fees, and lengths of the application process.

Types of Commercial Real Estate

There are various types of commercial real estate.  They generally consist of the following:

  • Office
  • Retail (malls, banks, restaurants, etc.)
  • Industrial (warehouses, manufacturing sites, etc.)
  • Multi-family (high-rise condominium units and smaller multi-family units)
  • Special purpose (churches, car washes, storage facilities)

What do Lenders Consider?

There are three sets of requirements that lenders consider when evaluating if they should grant a commercial loan to your business.

Business finances: lenders typically will look at your books to verify your business has the necessary cash flow to repay the loan. Your company’s debt-service coverage ratio will be calculated as well.

The debt-service coverage ratio divides a property’s annual net operating income (NOI) by its annual mortgage debt service. Lenders look for a debt-service coverage ratio of 1.25 or above, which indicates a positive cash flow. For example, if you apply for a $100,000 commercial real estate loan and your business is debt free, your NOI needs to be at least $125,000.

Your business credit score will also be evaluated to determine the interest rate, down payment, and payback term. The structure of your business should also be an LLC, LP, S, or C corporation. If you have a sole proprietorship then the loan would be considered personal rather than commercial meaning your personal wealth will be at risk in case you default.

Personal finances: your personal history and credit score will be evaluated to see if you have had any defaults, foreclosures, tax liens or more on there. You may not get approved if your personal credit score is low.

Property characteristics: the lender will attach a lien to the property that allows seizure if you don’t make your timely payments. Your business is required to occupy at least 51% of the building to qualify for a commercial real estate loan. A lender will then let you borrow up to a maximum loan-to-value (LTV) ratio – around 65-75% and the remaining must be put up as a down payment for the loan.

Applying for a Commercial Real Estate Loan

One thing that lenders look for when deciding to approve you for a commercial real estate loan is a detailed and clear business plan. They want to know what you are intending to purchase and what your plans are for using it. It’s important to be able to present a solid business plan to improve your chances of qualifying for the loan.

Proving your business’s financial strength is vital as well. Be prepared with financial documents of your business such as tax returns, asset statements, and any other financial information. Personal financial information and personal credit history will be evaluated as well.

Here is a list of items you need to meet the commercial real estate loan qualifications:

  • Business tax returns of up to three to five years
  • Financial reports, records, books for up to five years or since inception
  • Projected cash flows for the life of the loan
  • Personal and business credit reports
  • A third-party appraisal of the property
  • A solid business plan
  • Proof of citizenship depending on the type of program

Typical real estate loan requirements depend on the lender but in most cases a borrower will need the following to get a commercial real estate loan.

  • A personal credit score of 600 or higher
  • At least two years in business
  • Annual revenue of at least $50,000

Note that the lender may ask for more documentation during the application and approval process. The faster you can provide the lender the required documents, the fast you can get approved.

Remember to look at the various loans made available to you and take the time to review the process of how commercial real estate financing works. Knowing what to expect will make the process a lot easier when you are prepared with the information. When you have found the good fit, you are on your way to getting the loan you need to grow your business and bring it to the next level.