What Are Commercial Mortgages?
Aug 16, 2017
Most folks new to the real estate market seem to have a fuzzy impression of what the term “commercial real estate” means, but in a sense, we’re all experts. You don’t need to be a commercial real estate investor to have a ton of experience with commercial real estate. That movie theater you visited last weekend? Commercial real estate. That strip mall near your home? A commercial real estate property. Your office building? The apartment complex you lived in during college? You get the idea.
If you couldn’t already pick out a commercial property at a glance, you may be able to now. But still, the commercial real estate world is a bit blurry for most. What makes a property a piece of commercial real estate, or CRE? How does one purchase them?
And of course, probably the most commonly-asked question:
What Is a Commercial Mortgage?
Understanding what a commercial mortgage requires laying a foundation first. For example, what qualifies a piece of real estate as commercial real estate?
Strictly speaking, real estate is considered “commercial” real estate if it is income-producing and used solely for business purposes. While a non-rented family home would be referred to as a residential property, commercial buildings include office complexes, retail centers, apartments, hotels, single-tenant box stores, warehouses, and the like. Borrowers seeking commercial financing to purchase these properties will take out commercial loans.
The next distinction we need to make is the difference between commercial loans and commercial mortgages. The difference is simple: A commercial loan is just like any loan, outlining the repayment, interest, and other details about the loan. What makes any loan a mortgage—whether it be a commercial or residential loan—is the mortgage agreement. The mortgage agreement places a lien on the property and establishes that in the instance the borrower defaults on the loan, the deed to the property will be transferred to the lender.
Let’s put that all together: A commercial mortgage is a commercial loan secured by a lien on the subject property.
Commercial Mortgage Terms
Since the crucial difference between commercial mortgages and residential mortgages are the underlying property, many of the terms related to commercial mortgages are the same. It’s the differences we think are most important to dive into, so here’s a couple.
1. Loan-to-Value Ratio
Both residential and commercial loans use a figure called the loan-to-value ratio, or LTV. This ratio represents the value of a loan against the value of the property – lenders calculate this figure by dividing the amount of the loan to the property’s appraised value. For example, the LTV of a $900,000 loan on a $1,000,000 property would be 90%.
Commercial loan LTV are generally much lower than residential LTVs – often in the 65%-80% range—and vary based on the type of property in question. Lower LTVs mean that the borrower has a higher stake in the property, and equals less risk for the lender.
When applying for a home mortgage, generally a loan officer or mortgage broker will run your credit and look at your tax returns – these provide the lender insight about the borrower’s ability to pay the mortgage. Most folks diving into the commercial mortgage realm for the first time assume that the information required will be fairly similar, which is not correct.
For commercial real estate, lenders will first take a look at the subject property. The lender will be examining income sources, tenant rolls, and the operating history. While credit history is important to most commercial mortgage lenders, these lenders also emphasize the subject property’s ability to provide income and maintain the loan.
The Commercial Mortgage Loan Process
Because of the size and nature of most commercial mortgages, the commercial mortgage process can take a while – up to a few months. Here’s what takes place during this timeframe.
1. Preliminary Analysis
This is where those financials come in. The commercial real estate lender is going to need information such as tenant lease agreements and information, a current income roll, the ownership structure, exterior and interior photos of the property, the borrower(s) financial statement, and more.
These can vary based on the type of structure, but the underlying principle is the same: They’re trying to determine the commercial property’s ability to service the loan. Will it be able to generate a consistent flow of income to pay the mortgage and all its normal expenses (taxes, insurance, etc)?
Despite these financials, conventional commercial lenders will still want to see a solid credit history and strong financial background to proceed forward with the loan request.
2. Loan Processing
Should the lender proceed forward with the loan, they will issue a Letter of Interest, or LOI indicating potential loan terms. If these terms are acceptable to the borrower, they will sign the LOI and make a good-faith deposit. There are a lot of different pieces of information to get sorted out at this point, largely to do with the commercial loan application package.
3. Underwriting and Loan Review
If the loan file at this point meets all the lender’s guidelines, the underwiter may issue a final loan commitment letter. This underwriter has the option to issue conditions: pre-funding conditions, post-funding conditions, or adjustments to the loan amount to keep the request in line with the lender’s guidelines. They can also deny the loan at this point.
4. Loan Closing
Here is when the borrower accepts the terms lined out in the loan commitment letter – similar to within a residential mortgage. Escrow will deliver loan instructions and documents, while also ensuring everything needed by the lender is taken care of. At this stage, a clean title will be confirmed, the assignment of the loan will be finalized, and the funds will be disbursed.
Should I Get a Commercial Mortgage?
If you’re in need of funds for a commercial property and you think you wish to pursue a commercial mortgage, traditional lenders may be able to help out. Commercial mortgages are a reliable option for many business owners.
However, depending on your situation, there are other options. Hard money loans require fewer financials and often provide faster funding, which can be huge benefits for commercial borrowers without the credit history, financials, or extended timeframe needed by traditional commercial lenders.
Weigh the options and consult with your financial advisor, because finding the right choice is up to you.
This article was originally posted on November 11, 2016 and updated on August, 16, 2017.