Learn all about commercial real estate loans. Navigate the landscape of different loan types, ranging from term loans to SBA loans.

Commercial real estate loans are the primary financing tool to acquire commercial real estate property. In this comprehensive guide, we'll explore the nature of these loans, how they work, key differences from residential loans, and analyze the various types of commercial real estate loans that are available.

What is a Commercial Real Estate Loan?

A commercial real estate loan is a financing product designed specifically for the purchase, renovation, or construction of a commercial real estate property. Investors and developers borrow commercial real estate loans to acquire or develop office, industrial, multifamily, shopping centers and other real estate properties. 

Commercial real estate loans are available from a variety of sources, including traditional lenders such as banks to alternative private lenders.

How Do Commercial Real Estate Loans Work?

Commercial real estate loans typically work like residential real estate loans. A borrower borrows a commercial real estate loan from a lender, who provides funding to the borrower. Each lender sets the loan terms, interest rates and underwriting process. There are various loan structures, each with separate duration, interest rate type and payment structure.

For example, loans may have a fixed or variable interest rate, include both interest and principal, or be interest-only payments with a final balloon payment.

Commercial vs. Residential Real Estate Loans: Key Differences

While commercial real estate and residential real estate loans have many similarities, key differences remain. For example:

Purpose: Both residential and commercial real estate loans are used to acquire properties. However, as their respective names suggest, commercial real estate loans are intended for commercial or business use. In contrast, residential loans are used to purchase a home. 

Loan Duration: While residential loans can have a loan term of up to 30 years for a home mortgage, commercial real estate loans have shorter duration, such as 5 to 20 years. 

Interest Rates: Commercial loans typically have higher interest rates than residential real estate loans due to higher risk.

Underwriting: The underwriting process for a residential and commercial real estate loan also can differ. For example, when a lender underwrites a residential property, the lender evaluates the borrower’s income, debt and overall credit profile. In contrast, lenders underwrite commercial real estate loans based on the potential cash flow of the commercial property. 

Down Payment: Commercial properties often require a higher down payment, which can be up to 30% or more. In contrast, residential mortgages often have a lower down payment, which could be 20% or less. 

What is Loan-To-Value (LTV)?

Loan-to-value is a popular financial ratio used in real estate to evaluate the amount of a loan relative to the value of the property. For example, if a property is worth $10 million and the loan is $7 million, then the loan to-value, or  LTV, is 70%. Lenders use loan-to-value to determine the risk of the loan. A higher LTV typically means more risk.

What Are the Main Types of Commercial Real Estate Loans?

There are various types of commercial real estate loans, including term loans, lines of credit and construction loans, among others.

Term Loans: Term loans have predetermined lengths, often between 5 to 20 years, with regular monthly payments.

SBA Loans: Backed by the U.S. Small Business Administration, SBA loans are designed to help small businesses to acquire commercial real estate. Two primary examples include 7(a) and 504 loans.

Line of Credit: A line of credit is similar to a credit card and enables a borrower to access short-term financing up to a predetermined limit. 

Bridge Loans: Bridge loans are a short-term solution funding solution to “bridge” the gap between short-term funding needs and long-term financing requirements. 

Construction Loans: As the name suggests, construction loans are available for construction projects or major renovations. 

Hard Money Loans: A borrower may access a hard money loan from a private lender if the borrower can’t access a traditional bank loan or decides to pursue alternative financing. Investors may choose hard money lenders due to the faster underwriting process, but often pay a higher interest rate compared to traditional bank debt. Hard money loans are typically based on the property value rather than the borrower's creditworthiness.

Each type of commercial real estate loan may have its own fees. That said, a commercial real estate loan may have origination fees (charged by the lender to process a new loan), underwriting fees (charged by the lender to assess the loan’s risk) and appraisal fees (to determine the property’s value).

Conclusion

Understanding your loan options for commercial real estate is critical. This guide outlines popular forms of financing to help you understand how investors and developers use debt financing to acquire, develop and renovate properties.