Three Important Facts You Need To Know About Commercial Loans
Jan 15, 2017
What about Commercial Real Estate Loans?
People leave their homes every day and go into commercial buildings to work, to go shopping, watch a movie, eat out, get to appointments, and generally take care of all of life's activities. Yet, most people know very little about what commercial real estate loans are and how they work. Now, the term "commercial property" is a pretty generalized description. Within this classification, there are specific segments such as: multi-family properties (5+ unit apartments), office buildings, retail centers, industrial/warehouse, mixed-use, single-tenant box buildings (like Home Depot or a McDonald's), and specialty use (such as schools, churches, gas stations and car washes). But regardless of the type of commercial property, a person looking for a commercial mortgage needs to know that getting this type of loan is different than obtaining a residential home mortgage.
A borrower looking for a commercial loan needs to know 3 important facts before getting started.
(1) Getting a commercial loan requires more than a strong credit history and personal financials
When you apply for a home mortgage, the first things a loan officer or mortgage broker asks to do is run your credit and see a copy of your prior 2-year tax returns, most recent pay stubs, and current bank statements. A borrower's ability to pay the mortgage is a residential lender's main focus.
In comparison, when a borrower applies for a commercial real estate loan, a lender will first look at the condition of the subject property and its capability to service the loan along with its day-to-day operations. A lender will request a copy of the property's current lease roll (rent roll), any additional income sources, 2 year operating history with year-to-date information, recent capital improvements, internal and external property photos, a current mortgage statement, and/or purchase contract (if applicable). With this information, a lender will perform a debt-service coverage ratio analysis (DSCR) to determine if the property financials can support the loan request. Included with this analysis, a lender will evaluate the value of the property against comparable neighboring properties. If merited, a lender might also perform a preliminary environmental and title review if there are challenges that need to be addressed upfront.
A commercial real estate loan borrower still needs to have a strong credit history and strong guarantor financials to qualify for the loan. However, a lender places strong emphasis on a subject property's ability to maintain itself and the loan.
(2) Different sources for commercial real estate loans
- Portfolio Lenders - These lenders are usually comprised of national and local banks, credit unions, and corporations with a commercial lending division. They are called portfolio lenders because they maintain the commercial loans they originate on their balance sheet until maturity, rather than having them securitized.
- Government Agency Lenders - There are companies that are authorized to sell commercial loan products funded by government agencies, such as Fannie Mae (FNMA) and Freddie Mac. Some national and local banks can also offer government-backed loan products alongside their own portfolio products. These government-backed commercial loans are pooled together, securitized and sold to investors.
- CMBS Lenders - These type of lenders issue loans called "CMBS Loans". The loans this type of lender can originate vary in property types, locations and loan sizes. The commercial loans originated by this kind of lender are transferred to its trust. The trust then issues a series of bonds of varying duration, yield, and payment priority for investors to purchase.
- Insurance Companies - Some insurance companies have also developed a commercial real estate lending division within their company. Insurance companies are not beholden to the same regulatory lending guidelines as the previous three options and therefore can originate more tailored loan packages that are outside the conventional lending box.
- SBA Loans - Borrowers who are looking to purchase a commercial property for their own business have the option to get a SBA-504 loan on the property and equipment. An SBA-504 loan can be used to purchase a building, finance property construction and/or purchase machinery and equipment.
- Private Money - Hard Money Lenders - For those borrowers whose credit and/or financials do not qualify for a conventional loan or have a property that has challenges - hard money loans may be a viable financing source. This type of loan typically has a higher interest rate and cost of money associated with the higher risk a lender would assume. Regardless of the higher costs, hard money loans do fill the need of a segment of the commercial real estate market.
(3) Commercial Loans can be Recourse or Non-Recourse
- A recourse loan means that a borrower is personally responsible for the fulfillment of the commercial real estate loan. Should their commercial mortgage go into default, the lender has the right to collect any balance owed to them from the borrower(s), even after they have taken possession of the property.
With a non-recourse loan, the lender is not allowed to collect what they are owed beyond taking possession of the underlying real estate collateral. However, note that with non-recourse loans, commercial mortgage lenders usually place a "bad-boy carve outs" clause into their loan agreement. These carve-out exceptions provide a lender with the opportunity to still go after a non-recourse borrower should they find evidence of specific borrower(s) actions such as: fraud, intentional misrepresentation, gross negligence or criminal acts, and misappropriation of property income or insurance windfalls.
A lender would obviously prefer to issue out recourse loans because it reduces their risk of lending. Conversely, a borrower would prefer a commercial real estate loan that is non-recourse because it lowers their exposure. However, circumstances can make one option more appealing or available than the other. For instance, a lender may offer a lower loan margin and interest rate to a borrower who accepts a recourse loan. Moreover, a particular asset class, lending situation or market environment might not allow a lender to offer non-recourse loans.