PRIMER ON COMMERCIAL REAL ESTATE FINANCE
Even You Old Pro’s Will Learn a Ton

COMMERCIAL LOAN QUICK START

Please forgive me if this first section sounds like a sales pitch; but I have an important concept to convey. Even if you are an old pro at commercial real estate finance, you will find our free commercial mortgage portal, C-Loans.com, to be a great way to quickly present your commercial loan request to hundreds of different banks.

Here’s that important concept:

Why present your loan to so many banks? There is a bank out there right now that is too flush with cash. The bank president is yelling at his senior vice president, “We need to make some commercial loans right now!” It is this too-liquid bank which will give you the largest new loan at the lowest interest rate. The C-Loans System (we spent $2.2MM writing this code) helps you to pinpoint that too-liquid bank.

Are you looking for an SBA loan to buy a building for your business? Grasp this concept: Every SBA lender is different.

Your application for an $600,000 SBA loan to buy a campground could get turned down by 19 banks, only to have the 20th bank approve your deal because the president of that particular bank happens to own a $300,000 RV and loves to camp. There are over 250 different SBA lenders on C-Loans, and in just four minutes you can submit your deal to all of them, six lenders at a time.

Are you looking for a loan to buy an investment property, like an apartment building, office building, and or retail center? Once again – The hungriest bank will give you the most leverage and require the smallest down payment.

Who is the hungriest bank? Among our 750 different banks, this changes daily, depending on which bank just got some loan payoff’s or some huge new deposits. Submitting your commercial loan using C-Loans helps you to instantly identify which SVP of Real Estate Loans is getting chewed out by his boss. Haha!

Does your deal have some black hairs? Maybe your company is losing money. Maybe you went through a divorce and went bankrupt two years ago? There are over 300 commercial lenders - subprime lenders and hard money lenders - on our portal who specialize in making less-than-perfect commercial loans. As you fill out your mini-app, you’ll see a section named, “Special Issues”. Just identify your concern. For example, “One of my two retail spaces is vacant; but unfortunately I have a balloon payment coming due, so I have to borrow right now.” Boom. The lenders will screen themselves, and the forgiving ones will reach out to you with offers.

WHAT IS A COMMERCIAL LOAN? (Prepare to learn something.)

The word “commercial” is just a fancy word for “business”, so a commercial loan is just another way of saying business loan. To really understand what constitutes a commercial real estate loan, it is easier to understand what it is not.

A loan secured by a single-family residence, a condo, a townhouse, a duplex, a triplex, or a 4-plex is considered to be a residential loan. In the parlance of the industry, such properties are known as one-to-four family dwellings, and loans secured by 1-4 family dwellings are considered to be residential loans.

Residential loans are special because they can be sold overnight to Fannie Mae or Freddie Mac in a pinch. Because they are liquid investments, loans secured by one-to-four family dwellings enjoy MUCH lower interest rates - as much as 1.25% lower.

Definition of a Commercial Loan: A commercial real estate loan is therefore a real estate loan that is NOT secured by a one-to-four family dwelling. A land loan is an example of a commercial real estate loan. Surprised?

Example:

You own a four-plex, and all of the units are rented out to tenants. You are holding the property as an investment to provide income for your retirement. You want to refinance your four-plex to pull out some equity in order to buy a five-plex. The loan against your non-owner-occupied four-plex is a commercial loan because it is an investment property, and the purpose of the loan is not for personal, family, or household purposes. True or false?

False! A loan on your existing four-plex is still a residential loan, even though the property is non-owner-occupied. As a residential loan, it will enjoy an interest rate that is at least three-quarters of a percent lower than the commercial loan that you will eventually get on your new five-plex.

Remember, the cutoff is four units. If the multifamily property has more than four units, you need to apply to a commercial lender. To get a residential loan on your non-owner-occupied 4-plex, you should apply to a residential lender, like Quicken Loans. To get a commercial loan on your new 5-plex, you should apply using C-Loans.

WHAT ARE THE DIFFERENT TYPES OF COMMERCIAL LOANS?

There are more than a dozen different types of commercial loans, although most real estate investors will only use one of the first five types:

Permanent Loans - This is the most common type of commercial real estate loan. A permanent loan is a garden-variety first mortgage on a commercial property. To qualify as a permanent loan, the loan must have a term of at least five years and some amortization. In other words, a permanent loan cannot just have interest-only payments. In contrast with residential loans, which often enjoy a 30-year amortization, most commercial permanent loans have a 25-year amortization. If the property is older than 35-years-old, the lender might even a 20-year amortization. The one exception to this rule is multifamily properties (apartment buildings). Most multifamily permanent loans have a 30-year amortization. Most commercial permanent loans are made by banks, and, with the exception of multifamily properties, have a maximum term of ten years.

SBA Loans - If your business partially-occupies a commercial property, this is the loan for you. SBA loans are NOT made by the Small Business Administration (“SBA”). The SBA merely guarantees certain commercial loans made by banks and specialty finance companies. If you have been in business for at least three years, you can get an SBA loan of 90% loan-to-value to buy a building for your business to occupy; otherwise, you’ll have to put 30% down. The SBA only guarantees a portion of an SBA loan, so the bank making the loan has some of its own dough at risk. This is why 19 SBA lenders could turn your deal down, only to have the 20th SBA lender approve your deal. There are over 250 different SBA lenders on C-Loans.

Construction Loans - These loans are used to pay for the construction of commercial buildings, residential subdivisions (tracts of houses), and residential condominium developments. Construction loans usually have a term of just one year, although a six-month extension can sometimes be negotiated for an extra point. The bank doesn’t just give the borrower $3 million and hopes he builds the apartment building, as opposed to skipping to Mexico. Instead, the bank only advances funds as work is completed. For example, when the grading is done, the grading contractor is paid. The interesting thing about construction loans is that while they have interest-only monthly payments, a reserve, funded by the bank, is created at the beginning of the loan to make these monthly interest payments. The borrower only has to pay interest on the amount of the construction loan that has been drawn down to date. In other words, the interest payment in month one is usually very small because the developer has used very little of the loan proceeds. Construction loans are made by local lenders, rather than by some big bank in faraway New York City, because someone from the bank has to go out to the property regularly to inspect the progress of construction before it approves any disbursements to the subcontractors. These visits are called progress inspections, and there is small fee to the borrower for each one.

Bridge Loans - A bridge loan is a short-term loan, and most bridge lenders can fund these loans very quickly (30 days versus the normal 75 days). Bridge loans have a term of between one year and five years, and they have interest-only monthly payments. Bridge loans are usually much more expensive than permanent loans or construction loans. Bridge loans are often used on valued-added projects, where the finished value of the project is projected to be much higher than the cost to acquire the property and to renovate it. They can also be used to give the owner time to find a tenant. Large bridge loans ($3 million+) are usually floating rate loans, tied to LIBOR. (Did you know that LIBOR will stop being computed on January 1, 2022 because of all of the corruption associated with its computation?) Another type of bridge loan is a short-term loan made by a hard money lender. Hard money bridge loans can be for any purpose, not just to renovate the property. Hard money bridge loans usually have a fixed rate. There are 300+ bridge lenders on C-Loans.

USDA Business &Industry Loans - You may have never heard of the USDA Business and Industry (“B&I”) loan program, but it is very similar to the SBA loan program. Some of the poorest Americans live in rural areas, where there are few job opportunities. The purpose of B&I loans is to bring jobs to rural areas, defined as cities of less than 50,000 in population. Unlike SBA loans, B&I loans do NOT require that the property be owner-used, as long as the loan is projected to bring jobs to the rural area. USDA B&I loans can be as large as $25 million, compared to just $10 million for an SBA loan. They can have fixed rates and have a 30-year amortization. That portion of the loan secured by equipment can have a term as long as fifteen years, compared to just ten years on SBA loans. There are 125+ USDA commercial lenders on C-Loans.

There are a whole bunch of other types of commercial loans, but most of them don’t apply to the typical commercial real estate investor. We will discuss them much further below in the section, “Other Types of Commercial Mortgages”.

WHAT ARE COMMERCIAL MORTGAGE RATES TODAY?

Let’s talk first about the interest rate on commercial permanent loans (garden-variety first mortgages). Earlier we mentioned that commercial mortgage rates are typically 75 to 125 basis points higher than residential mortgage rates. A basis point is 1/100th of one percent, so 125 basis points is 1.25%. Therefore, if the 30-year conforming mortgage rate is 4.0% today, then commercial mortgage rates would be around 4.75% to 5.25%.

Here is something that will surprise you. Banks from Maine to Florida, to California, and to Hawaii generally have almost the exact same conventional commercial mortgage rates, terms, and programs. There is almost no price competition in banking. Banks move together like a giant herd. Moooo.

The typical commercial permanent loan from a bank has a fixed rate for the first five years. Then there is one rate-readjustment to market. The interest rate is then fixed for five more years. The loan is amortized over 25 years, and it has a term of ten years. There is generally some sort of declining prepayment penalty, like 3-2-1 or 5-4-3-2-1. There will be a six-month window at the end of five years, and then the prepayment penalty will apply again to the second five years. And remember, most banks have this exact same program.

So what is the interest rate? You can predict it with some precision. Just look up five-year Treasuries on the internet and then add between 275 to 350 basis points (2.75% to 3.5%). Therefore, if five-year Treasuries are 2.0% today, your rate will be between 4.75% to 5.5%. Obviously, only the very best deals get the lowest rate.

What about SBA loans? Most SBA loans are made using the 7a Program, which is a 25-year, fully-amortized, floating-rate loan. The rate is tied to prime, with a margin of 1.5% to 2.75%. Almost all SBA loans are closed at 2.75% over prime. Your deal would have to be pretty awesome to qualify for a margin of only 1.5%.

Commercial construction loans are typically priced at prime + 1% to 1.5% floating, 1 to 1.5 points, one year, interest-only.

Bridge loans vary greatly in price, depending on the quality of the deal and the borrower. High-net-worth borrowers, on large, good-quality properties can get floating-rate bridge loans tied to LIBOR, with a margin as low as 4.5% to 5.5%. (LIBOR is really-really low.) Average deals to clean borrowers might be priced at 6% to 8% floating over LIBOR. The points would be 1.5 to 2.5.

Hard money bridge loans are typically fixed rate loans with rates as low as 8% (in California), 9% to 10% nationwide, and sometimes as high as 12% to 13% on riskier deals. The points are typically 2 to 3.

Few people know about the USDA commercial loan program, but the program is terrific. If the deal is really good, you can negotiate a fixed rate and a 30-year amortization; otherwise, the rates and terms on a USDA Business and Industry loan are similar to those of SBA loans.

HOW DO COMMERCIAL LOANS WORK?

Commercial loans almost always need to be secured. Unsecured lines of credit are difficult to obtain, unless the loan amount is fairly small (less than $100,000), your net worth is very high, you keep tons of cash in the bank, and your credit is perfect.

The collateral available to serve as the security for your commercial loan determines the type of commercial loan you can get and the kind of lender to whom you should apply.

If the collateral is a multifamily property (apartment building), then you would apply for a multifamily loan to either a life company, a conduit, a bank, or an agency lender specializing in multifamily loans. Agency lenders include Fannie Mae, Freddie Mac, and Ginnie Mae. We will discuss agency lenders in more detail below.

If the collateral is an investment property, like an office building, retail property, strip center, shopping center, industrial building, warehouse, mobile home park, or self-storage facility, you will likely apply for a permanent loan to either a life company, a conduit, a bank, or a credit union. Life companies seldom lend on anything other than office, retail, and industrial properties.

If the property is owner-occupied by your business, you would most likely apply for an SBA loan to a bank or a specialized SBA lender.

If the property is located in a small town or rural area, you may want to apply for a USDA loan to a bank or a specialized USDA lender.

If no real estate is available, and you are trying to buy or borrow against some equipment, you would apply for an equipment loan to either a bank or an equipment finance company. You could also apply to a leasing company to just lease the equipment.

If your proposed collateral is your accounts receivable, you would apply for an accounts receivable loan to either a bank or a specialty finance company. If you were really-really desperate, you could actually sell your accounts receivable to a factor at a huge discount. Ouch! This method of financing your business is called factoring.

If your proposed collateral is your inventory of, say, 100 completed surfboards, you would apply for an inventory loan to either a bank or a specialty finance company.

Most commercial real estate loans have balloon payments. There are three major exceptions - multifamily loans, SBA 5a loans, and USDA Business and Industry loans. These last three loan types usually enjoy long-term, fully-amortized loans.

Unfortunately, C-Loans does not place business loans not secured by real estate.

WHO MAKES COMMERCIAL LOANS?

Below is a list of the major types of lenders who make commercial real estate loans. They are listed in order, which the cheapest, most desirable lenders at the top.

Life Companies - A life company is just short for a life insurance company, and they have, by far, the cheapest commercial mortgage rates. Their interest rates are probably 35 to 45 basis points cheaper than conduits, the second cheapest type of commercial lender. There are two key things to understand about life companies: (1) They only make fixed rate loans; and (2) they never want to get paid off early. The reason why is because life companies work off of actuarial tables to pay their death benefits, so they need to know exactly how much they will make (fixed rate) and exactly when they will get paid off (no early prepayments). Because they are the prettiest girl at the dance, they get to go home with the quarterback. Their typical minimum loan is a whopping $5 million. They will only finance very standard property types - multifamily, office, retail and industrial properties (the Four Major Food Groups) - in the nicest areas of Football Team cities. And if that was not picky enough, life companies will rarely exceed 60% loan-to-value. In forty years, I (George Blackburne III, the old attorney) have never successfully closed a loan with a life company.

Conduits - Conduit is short for Real Estate Mortgage Investment Conduit (“REMIC”). Conduits are specialized commercial mortgage companies that originate very large ($5 million and up) commercial real estate loans on the Four Major Food Groups. These are deals with a slightly higher LTV’s than a life company would tolerate and/or properties that are not quite pretty enough or well-located enough for a life company. These conduit loans are very cookie-cutter and plain vanilla. The loans are thrown into a huge pool. When the conduit has amassed at least $1.5 billion of these cookie-cutter commercial loans, the pool is rated by Moody’s or Standard & Poor’s, and then the pool is securitized. Securitization means that bonds (IOU’s) are issued, secured by the loans in the pool. If you were to buy one of these bonds, you might own 1/300,000th of this pool of loans.

Commercial Banks - A commercial bank is just a garden-variety bank that accepts deposits and makes loans, in contrast with an investment bank (which sell stocks or takes companies public) or a merchant bank (they invest equity in companies rather than make loans). Banks will make commercial real estate loans as small as $100,000 to as large as $300 million. Banks will finance almost all commercial property types, including construction loans on residential subdivisions and permanent loans on restaurants, as long as the borrower is making money and has plenty of cash in the bank. The only exception is politically-incorrect properties, like casinos, gentlemen’s clubs, and pot dispensaries. A good rule of thumb is to never apply to a bank for a loan if you need money. Huh? Sell something and put some cash in your bank account first. Then apply to the bank for a loan. If you know you will need cash in March, apply for the loan in August of the prior year, when your busy season has just ended and you are flush with cash. Here is another good rule for dealing with banks. Banks greatly prefer to make short-term loans to high-net-worth individuals (memorize this banking term of art), who maintain large cash balances in their bank. A good way to get a borderline deal approved is to approach a small bank and promise to move all of the borrower’s accounts to this small bank.

Credit Unions - Credit unions have come out of nowhere in recent years to seize 6% of the commercial real estate loan market. They offer the same interest rate and terms as commercial banks, without the weirdness of only lending to liquid borrowers. If you have good credit and your commercial loan cash flows, they will make you the loan in a heartbeat, even if you have very little cash in the bank. It used to be that you had to work for a particular company in order to qualify for a loan from a credit union; but those days are long gone. Today, all you have to do is live in the same state as the credit union OR own a property in that same state in order to qualify. The credit union, by law, will require that you open a token account with the credit union.

REIT’s - A REIT is a real estate investment trust. It’s basically a corporation that invests exclusively in real estate and/or mortgages. For tax reasons, a REIT must distribute 90% of its taxable income as dividends. There are very few surviving mortgage REIT’s, and those few that still exist today make mainly expensive bridge loans; but they are still cheaper than hard money lenders.

Hard Money Lenders - With the rise of crowd-funding, there are now almost 1,000 commercial hard money lenders across America scratching and clawing for deals. The good news is that this has driven down hard money mortgage rates down below 10%, and, in California, to as low as 8%. God bless capitalism. Quick joke: Why do communists only write using lower-case letters? Answer: They hate capitalism. Haha!

OTHER TYPES OF COMMERCIAL OR PERSONAL-PROPERTY-SECURED BUSINESS LOANS

Agency Loan - An agency loan is typically a multifamily loan or senior housing loan that is guaranteed by some government-sponsored enterprise (“GSE”), such as Fannie Mae, Freddie Mac, or Ginnie Mae. Agency loans have 30-year terms and a terrific, low, fixed rate. The minimum agency loan is $1 million, and the process is a little slow.

SBA 7(a) Loan - The SBA 7(a) program is a 25-year, fully-amortized, first mortgage loan program with a floating rate, tied to the Prime Rate. It is the most common type of SBA loan. The maximum loan amount is $5 million.

SBA 504 Loan - The SBA 504 loan program starts with a conventional, fixed-rate, first mortgage, which is typically made by a bank. The first mortgage usually has a term of ten years. Behind this conventional first mortgage, a local community development corporation will make a 20-year fully-amortized, SBA-guaranteed, second mortgage. It is the most common way to get a fixed rate SBA loan. The maximum SBA 504 loan is $10 million combined.

Takeout Loan - A takeout loan is simply a garden-variety permanent loan that pays off a construction loan.