Business is often about overcoming obstacles. Depending on the way you view obstacles, they can become opportunities or hindrances. Two of the most challenging obstacles for small business owners are buying commercial real estate and getting equipment. That’s the reason so many financial products exist to address these two needs.
You can see buying property for your business to operate from in one of two ways: a burdensome but necessary expense or an opportunity for growth. Yes, commercial property is expensive and typically necessary. You can rent space for your business, but then your money is going to someone else’s benefit. The way you finance your CRE highly influences your return on the property. The decisions you make at this stage are crucial to determining how well your investment goes, even before the property is in your company’s name.
In addition, the value of equipment in an industrial facility often exceeds the building it’s housed in. We tend to think of CRE as more expensive simply because it’s larger, but highly specialized medical, industrial, and technological equipment can cost millions if not billions of dollars. Equipment, like CRE, can build equity for your business. So it’s important to get the right financing from the start.
In this article, we’ll focus on commercial real estate (CRE) and Commercial and Industrial (C&I) financing and where to find it. Let’s start with the way traditional lenders approach these types of loans.
Traditional CRE Loans
In their basic form, traditional CRE loans are long-term loans that will finance the purchase of commercial property. Amortization of these loans is often around 20 years. Amortization usually exceeds the loan term, making interest rates lower over the course of the loan, but requiring a lump sum on the balance at the end that can be refinanced or paid off, depending on the business’s strategy at the time.
All traditional CRE lenders have similar criteria for approving these loans. For them, the most attractive deals are those with low leverage, low risk, and high returns. Those deals are usually rental properties with longer lease terms and reliable tenants. If you’re buying retail property, for example, a bank would be more willing to approve a loan if your tenant is Starbucks than if it were a small, independent drive-thru coffee shop. That’s because the lender sees Starbucks as having higher earning potential and a more stable business model.
Traditional C&I Loans
Commercial & Industrial (a.k.a. Business & Industrial) Loans are for businesses that want to manage their equipment and working capital needs. Most traditional C&I loans require non-real estate collateral and have variable interest rates. Terms are much shorter than for CRE loans, typically no more than a year or two. Startups frequently use C&I loans to bring in inventory and hire staff.
To get a C&I loan from a traditional lender, you’ll need to undergo at least a basic underwriting process that accounts for all the risk potential and mitigations for the lender. That’s partially because these lenders have to meet FDIC regulations and other laws. Lenders want to know about cash conversion cycles, cash flow, and receivables aging. The longer your company has been in business, the higher your chances are of being approved by a traditional lender.
Traditional CRE and C&I loans are suited to the lender’s needs, not necessarily the borrower’s. They tend to be rigid and not customized to the businesses that use them. The low leverage demanded by traditional lenders creates the opportunity for non-traditional lenders to fill the gap. Following are some examples of flexible loan types and how they can be used to benefit your business when traditional loans don’t meet your needs.
Private capital loans are short-term asset-based financial products for businesses that want to move fast. They don’t require the rigorous underwriting of traditional C&I or CRE loans, allowing borrowers with lower credit scores to qualify. If you’re a fix and flip investor, this type of loan can be ideal because they let you act quickly on deals but don’t lock you into a long-term loan. Private capital loans can be used for CRE acquisitions, equipment, and working capital.
In the past, only high-risk borrowers used what were called “hard money loans.” That gave this type of short-term financing a bad reputation. However, most of the problems with this type of lending ended in the 1980s. Despite some lingering misconceptions, today all types of businesses choose private capital for its advantages.
When a business needs working capital, its options are far more diverse than they are with CRE and C&I loans. Private capital loans can provide additional cash flow, but the choices don’t end there.
Factoring is the sale of a business’s unpaid accounts receivable assets to a factoring company. The business selling it gets a percentage of what those assets are worth in a lump sum. The factoring company then collects directly from the customer owing on the account. Once they’ve been repaid by the customer, they subtract a factoring fee and forward the remainder to the original business. Factoring offers the opportunity for borrowers to get a boost in cash flow without taking out a loan, providing collateral, or relying on their credit score.
Lines of Credit
A line of credit is a revolving account that borrowers can take from and pay back into so they can borrow the balance again. They are one of the most flexible options for working capital for small businesses out there. Lines of credit can be secured with collateral assets or unsecured with qualifying credit. As long as payments are kept current on the account, the line can remain open and available whenever a business needs more cash flow. If there’s no balance on the account, there’s no interest charged (but there may be other fees).
Whether you’re a startup or have been operating for decades, having financing tailored to fit your needs is key. Leveraging the right financing grows your business instead of dragging it down. To learn more about how to create opportunities with real estate, equipment, and working capital, talk to a qualified broker.