If you’re purchasing or renovating commercial real estate, you will likely need to take out a loan, especially smaller businesses. Investors and developers need to be intimately familiar with the types of loans available and what the terms mean, as any commercial real estate investor or developer will certainly take out multiple loans in the course of your business. After all, it can be difficult if not impossible to come up with hundreds of thousands of dollars—or more—on the spot, particularly when your business is just starting. Learning about your commercial financing options will help you make the best possible choice for your company.
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Lenders will probably review your business finances, personal finances and the property you wish to purchase, among other factors, to determine whether you qualify. While you may not qualify for every type of commercial real estate financing, there are plenty of options to investigate.
Commercial real estate mortgage
Mortgages are the most popular type of commercial real estate financing, and operate much the same as a home mortgage. They often offer the most attractive options, but it’s important to consider several different factors before signing on the dotted line.
First, what percentage of the building’s value will the mortgage company finance? This is called the loan-to-value ratio, and it usually ranges from 75 to 100 percent of the building’s value. If they won’t lend the full amount, you’ll have to come up with the funds elsewhere.
Second, look at how flexible the lender will be in repayment, and what kind of options they can offer. For example, you may be able to hold off on payments for a year or two to help your business recover from the moving costs. You should also inquire about whether they accept temporary deferments, forbearances or interest-only loans in the event your business experiences an economic downturn.
Finally, consider the amortization period. The longer the period, the better—it means that your company will be able to retain more of its money in the short term, which can be crucial after large investment. Generally, commercial real estate mortgage loans range from about five to 30 years, although there can always be exceptions on either end of the spectrum.
Leasehold improvement loan
Leasehold improvement loans are short-term loans—often about five years—that are useful for making renovations to leased properties. Collateral can be the improvement itself, depending on your lender, and you may be able to defer payments for up to a year.
Working capital loan
Working capital loans are also short-term loans that can be used for commercial real estate. These unsecured loans are also good for making renovations, moving properties (which is often more expensive than a business owner may expect) and retrofitting your building. These loans may be amortized over as little as five years, so consider the terms when deciding how much money to borrow.
Demand loans can be paid back in full or in part at any time without penalty; they have no fixed maturity date attached. That makes them an extremely flexible option. However, be aware that the lender can also demand payment back at any time.
Equipment loans are a smart way to purchase the necessary equipment or machinery for your property. Lenders consider the equipment itself collateral, and the amortization period runs along with the lifespan of the equipment.
Business line of credit
Does your business have a line of credit? If so, you may want to investigate this option for smaller investments, such as improvements or to cover a downturn in business. Bear in mind that because they are short-term loans, their interest rate will be higher. However, they can be a boon in an emergency.
Vendor loans and financing
Vendor loans, also known as seller financing, are an option when you have a large commercial vendor moving into your property. They can be secured by a stake in ownership or a lien on the property and maybe a more flexible option than going with traditional lenders. Many can be paid out as soon as you sell the property, without penalty. Before choosing a vendor loan, it’s important to determine whether the vendor lender is sufficiently able to cover the cost of the loan and what kind of terms they expect to see—you may be better off with a traditional mortgage, but vendor loans can be great in a pinch.
Commercial bridge loans
Bridge loans are short-term loans that are designed to front cash while owners finish a property transaction. This can be selling a property, refinancing, leasing or improving one. They often come with a significantly higher interest rate, and often only last 6-12 months. To put them into perspective, many house flippers use bridge loans to purchase a property, renovate it and put it back on the market; the idea is that the sale of the property will be enough to cover the loan, interest and make a profit.
Ultimately, which commercial real estate financing option you choose will depend a great deal on your company’s finances, whether your funds can make up for any difference remaining and how well the terms mesh with your goals as an investor or developer. Before you enter into any lender relationship, be sure to investigate exactly what the terms mean for your business in both the long and short term—your accountant should be able to advise you on which types will be feasible to repay and in what time span.
Financing your commercial real estate purchases and improvements isn’t a one-size-fits-all proposition, however. What works for one business may not for another, so explore all of your options before making a decision.