When a business needs to establish a physical location the first thing they consider is the old adage “Location, location, location”. What they should really consider is “financial, financial, financial”. Understanding the different types of real estate loans, which ones will apply to which properties, and how they will affect your business, is the first step to figuring out the best path forward for your company’s real estate needs.
Commercial real estate loans
The difference between a commercial real estate loan and other loans is a complex one. For each, the bank balances the risks differently when deciding whether or not to provide the loan to the borrower. Unlike residential loans, commercial real estate loans come with two types of terms: intermediate-term loans of 3 years or less and long-term loans that last for 5 to 20 years. This refers to the time it is expected to pay off the loan and the interest it collects. The intermediate loans provide smaller capital and are meant for easier to pay off purchases or for companies with large financial capabilities, while the long-term loans have larger loan amounts. In general, both types of commercial real estate loans tend to come at a steeper interest rate than a residential mortgage.
These types of loans come from commercial banks, which traditionally make them the better option for a small business, however, they also require an established credit score, strong financials, a solid company history, and a detailed business plan in order to acquire. The loan is also insured by placing a lien on the property purchased with it. If the owner defaults on the loan, the bank claims ownership in order to recoup its losses.
SBA Loans and why they work for you
The SBA offers assistance for commercial loans through their CDC/504 loan program. A CDC/504 Loan is made specifically for purchases of fixed assets. This means that the purchase needs to be a long-term item, like a building or renovations. A CDC/504 loan from the SBA will have either 10 or 20 years payback schedule, which is often longer than what a traditional CRE loan will provide. The other major benefit is that it gives the borrower a fixed interest rate instead of the prime lending rate. The prime lending rate can rise or fall, having an impact on the interest of a loan. By providing a fixed rate a CDC/504 will ensure that small businesses are not put in the difficult situation of watching how their interest changes.
CDC/504 loans do have qualifications that a business must meet in order to ensure approval. To qualify, owners need to present a feasible business plan and demonstrate some business management expertise. Additionally, their net worth must be less than $15 million and have a net income of less than $5 million after taxes. This ensures that only small businesses are approved and that the owners have the capability to pay off the loan.
Hard Money loans should be temporary
Hard money loans are asset-based loans which are secured by real property. This means that the owner must put up real property as collateral, such as another commercial property, or even a personal house. The underwriting of the loan is determined by the ratio of loan amount divided by the value of the property, and most of these loans are used for short-term projects of a few months to a few years. This makes them ideal for remodeling or rapid property purchase. However, we work with clients to move from this rapid to acquire, short-term financing into longer-term real estate loans for any properties that they are looking to hold in their portfolio.
Non-real estate loans
Non-real estate loans are great if the borrower needs cash and doesn’t want a mortgage. They can provide an immediate influx of capital, without the additional personal risk of a real estate loan or hard money loan. However, they often have a higher interest rate and can have a more direct impact on the credit of the borrower if they default. This makes them great for small purchases, quick purchases, and remodeling, or any other project which can be paid off in a few years, but not ideal for larger purchase or projects.
Your unique situation
None of these financing vehicles is a “one size fits all” tool. The starting place is to compare your goals and current needs against the pros and cons of each different type of loan in order to select the best fit. If you’d like help with that process, our team is always available.