Commercial Real Estate Loan

Updated on March 19, 2024
Article byKhalid Ahmed
Edited byKhalid Ahmed
Reviewed byDheeraj Vaidya, CFA, FRM

Commercial Real Estate Loan Meaning

A Commercial Real Estate (CRE) loan refers to a special loan utilized to fund the purchase of or refinance a commercial real estate properties like office buildings. It acts as a loan vehicle to fund the renovation, purchase, acquisition, or development of income-creating commercial properties for businesses.

Commercial Real Estate Loan

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Lenders secure these loans using the property, which is being financed by paying an upfront substantial down payment accompanied by a good credit score of the borrower. Credit unions, banks, or specialized commercial real estate lenders can offer CRE loans. The duration and interest rate of the loan depends on the borrower‘s credentials & financial situation, lender discretion, and the type of property.

Key Takeaways

  • A Commercial Real Estate (CRE) loan is a special loan that finances the purchase, refinance, renovation, or development of income-generating commercial real estate properties like office buildings.
  • Borrowers must have good creditworthiness, good market valuation, excellent cash flow, loan-to-value ratio, ideal debt service coverage ratio, proper insurance, no environmental risks, clean title records, and adequate business experience to qualify for a commercial loan.
  • One usually uses it for business and income-generating purposes, whereas residential loans serve the purpose of providing residences, rental properties, and vacation homes.
  • It has many types like – conventional loans, SBA loans, bridge loans, construction loans, CMBS loans, hard money loans, and mezzanine loans.

Commercial Real Estate Loan Explained

A commercial real estate loan is a type of credit finance where the loan amount is used to purchase or develop commercial real estate by keeping the financed property as collateral. These loans have been long-term loan facilities repaid by the cash generated by the business operation, which is based on owner-occupied commercial real estate mortgage loans.

Moreover, the primary collateral is the lien-marked property which the loan provides finance for, and the owner-occupied properties secure the loans. Commercial real estate loan origination policy provides a guide on underwriting requirements and risks for non-owner and owner-occupied plus construction lending. The origination policies include:

  • maximum loan-to-value (LTV),
  • appraisal requirements,
  • maturity and amortization terms,
  • minimum debt service construction,
  • construction loan monitoring procedures,
  • pro forma analysis requirements,
  • interest rate sensitivity
  • pre-leasing requirements (as applicable),

Furthermore, to qualify for a commercial real estate loan, the business must occupy a minimum of 51% of the property. Otherwise, one may have to apply for an investment property loan. Loan terms, rates, and down payments may vary from lender to lender and property type, while repayment terms may range from 5 to 25 years.

Some loans get full amortization with fixed or variable interest rates having equal monthly payments. However, others require interest-only repayments with a final chunk of payment to be made towards the end of the loan. Many websites offer commercial real estate loan calculators for the purpose of calculating loan interest rates.

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Requirements

A lender or accept or reject a commercial loan application based on the fulfillment of the following requirements:

  • Borrowers must have good creditworthiness, as shown in their credit history, credit score, assets, and income.
  • The property proposed for mortgage or finance must have a good market valuation, be at a good location, and have the potential to generate good income. The borrower must be in possession of excellent cash flow as depicted in their financial statement, rent rolls, and tax returns.
  • It must have the loan-to-value ratio the lender needs per the property’s type and risk tolerance.
  • Lenders also check the ideal debt service coverage ratio for the borrowers to ascertain their ability to repay the loan amount through the income generated by the property.
  • Property must have proper insurance in place to cover losses due to fire or any loss to it.
  • The property should not have any environmental risks as per the environmental assessment by the lender.
  • Property must have clean title records without any litigation from any other party.
  • Most importantly, the borrower must have adequate business experience to ascertain their ability to use the property to generate income and make profits while also repaying the debt.

Types

There are several types of CRE for different types of borrowers, and they are as follows:

  • Banks and other financial institutions offer conventional loans, and they usually require a down payment of 20% of the property’s value.
  • SBA loans, provided by the Small Business Administration, have lower down payment requirements and longer repayment terms than conventional loans.
  • On the other hand, bridge loans act as temporary financing solutions until there is a long-term option. But they come with higher interest rates and fees.
  • Construction loans are specifically for financing the construction of new commercial properties or renovating existing ones, but they typically require a higher down payment and come with higher interest rates.
  • CMBS (commercial mortgage-backed securities) loans are pooled with other loans and sold to investors as securities and typically have longer loan repayment terms and lower interest rates.
  • One can secure hard money loans using the property itself. Borrowers with poor credit or who need quick financing use it, but they come with high interest rates and fees.
  • Finally, mezzanine loans are positioned between the first mortgage and the borrower’s equity in the property, usually have higher interest rates, and provide additional financing for already leveraged properties.

Commercial Real Estate Loan vs Residential Loan

Let us understand the differences between the two using the table below:

BasisCommercial Real Estate LoanResidential loan
Loan Purposeit usually gets done for business purposes and income-generating purposes.It serves the purpose of providing residences, rental properties, and vacation homes.
Loan AmountThe loan amount tends to be of larger value.The loan value is generally of a smaller amount. 
Loan TermThe loan term usually has a short duration.However, the duration of these loans tends to be greater in length.
Down PaymentIt has the requirement of a higher down payment.It requires the borrower to pay a huge amount as a down payment. 
Interest RatesIt has higher rates of interest. It allows the borrower to pay a lower interest rate on their loans.
QualificationThe requirements to sanction these loans are quite stringent.The screening process and eligibility criterion are a bit easier than the commercial loan.
AppraisalThe whole appraisal to disbursal has complexities involved and also has higher processing fees.The entire process of the loan, right from approval to disbursal of loan, turns out to be quite easy for the borrowers.
Type of borrowersIt mostly comprises big corporates dealing in real estate like REITs.It mostly encompasses individual borrowers in need of residential properties.

Frequently Asked Questions (FAQs)

1. What are commercial real estate loan rates?

The rates of commercial real estate vary as per the below factors:
– Borrower’s credit record and trustworthiness
– Loan term
– Property type
Moreover, the rates range between three to twelve percent but may fluctuate to the upper and lower circuit due to the factors mentioned.

2. How long are commercial real estate loans?

These loans tend to be of longer duration than other loans, reaching twenty to thirty years based on the lender’s discretion.

3. Are commercial real estate loans fixed or variable?

These loans could be either depending on factors such as:
– For a borrower in need of budgeting their expenses, they must go for fixed-rate loans as it provides predictable payments and stability. 
– A flexible rate loan is ideal if a borrower can afford the risk of increasing interest rates and the initially lower interest on loans.

This article has been a guide to what is Commercial Real Estate Loan. Here, we explain its types, requirements, and comparison with residential loans. You may also find some useful articles here –

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