Commercial Real Estate Loan Guide

• Commercial real estate loans can be term loans, SBA loans, lines of credit or portfolio loans.
• Most lenders require borrowers to have a credit score above 660 to qualify for a commercial real estate loan.
• Commercial real estate loans typically have five- to 10-year terms but are amortized over a term of up to 25 years, which may leave borrowers with a large balloon payment at the end of the term.
• This article is for business owners who need a commercial real estate loan to purchase a building or remodel an existing property for their business.

Chances are your business doesn’t have millions of dollars casually lying around for a commercial real estate purchase. That’s why, just like mortgages for residential home purchases, commercial real estate loans are a common funding source for small business owners. You can use a commercial real estate loan to buy or renovate virtually any property you’ll use for business purposes. 

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To get a commercial loan, you’ll need to have good credit, make a down payment of 25 percent or more and plan to use the majority of the property being financed for your own business. Below is everything you should know about obtaining a commercial real estate loan.

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When you’ll need a commercial real estate loan

While most people associate commercial real estate loans with investing in commercial real estate, the uses for these loans are more specific than that. Commercial real estate loans are designed to finance the purchase or improvement of property that is being used for your own business. To get a commercial loan, you need to use most of the property securing the loan for your own business purposes.

This means you can still lease out part of the underlying property, but at least 51 percent of the property needs to be used for your business. Meanwhile, if you plan to lease out 50 percent or more of a space, then you need a different type of loan as this is considered more speculative activity.

Here are some instances when a commercial real estate loan may be appropriate:

• Buying an office building to house your business
• Expanding or relocating retail space for your store
• Buying a warehouse to house your inventory
• Buying, building or renovating a hotel you will operate yourself

Commercial real estate loan rates, terms and fees

Keep in mind the information in the below chart, particularly the interest rate, is subject to change as the economy does.

Types of commercial real estate loans

There are several types of commercial real estate loans that can be used to finance commercial property. Each option has its own rates, terms, eligibility requirements and application process. Here are some of the loan types to consider.

Within the category of SBA loans, there are several loan products that can be used to buy, build or renovate commercial property. However, the SBA 504 Loan Program is specifically designed for this purpose. Funds provided through the 7(a) program can technically be used to buy or improve real estate, but the program isn’t ideal for financing real estate.

Another thing to be aware of with SBA loans is that the SBA is not intended to be a first-choice lender but rather a lender of last resort. Before applying for a loan from the SBA, you should seek financing from other lenders.

Also, within the area of portfolio loans, it’s important to note that these loans are often used by landlords who own a number of properties they are leasing to tenants. Lenders consider this more speculative activity, with different rates, terms and eligibility criteria. If you have a business that owns multiple facilities that you use for your own purposes, make this clear before exploring portfolio loan options with a lender.

Choosing a commercial real estate lender

When you’re trying to get a commercial real estate loan, there are many different loans and lenders to choose from, so it’s critical to find a lender that not only offers the type of loan you want but also has rates you can afford and qualification requirements you can meet.

Here are some things to consider when picking a lender:

• Available loan options
• Origination fees
• Starting interest rates
• Documentation requirements
• Time-in-business requirements
• Prepayment penalties
• Personal guarantee requirements
• Fast funding or bad credit options (if you need them)
• Better Business Bureau ratings and customer complaints

Commercial real estate loan requirements

Qualifying for a commercial real estate loan is very different from getting a home loan. Because you’re going to be using the property for business purposes — and paying back the loan with business revenue — lenders want to make sure your company can cover the loan payments.

The requirements for securing a commercial real estate loan fall into three main groups.

1. Security

Before approving a loan, your lender will want to know that the loan is properly secured by the property you’re borrowing against. This means you’ll generally need to have at least 25 to 30 percent equity in the property; if you’re buying, you’ll need a down payment of 25 percent or more to qualify.

In addition, your lender will want to ensure you have adequate property insurance to protect against damage to the property (their collateral). The lender will also run title work on the property and check the deed to make sure there are no outstanding liens or other claims against the property. [Related article: What Is a Lien?]

2. Income

When processing your application, lenders want to see that you have plenty of income relative to your expenses so they can be confident that you can make your loan payments each month. One metric that lenders use when making this determination is your DSCR. The minimum DSCR varies based on the property you’re borrowing against, but most lenders want a DSCR of 1.25 or higher. [Related article: Factors That Keep You From Getting a Small Business Loan]

To establish your income with the lender, you’ll need to provide two years of tax returns. This usually consists of business as well as personal because you’ll be borrowing the money for business purposes but will also need to sign a personal guarantee. You’ll also need to provide your business’s organization documents and operating agreement, as well as personal documentation, such as a W-9 and a copy of your birth certificate or passport.

3. Credit

If you’re getting a loan for business property, your lender will likely want to check your business credit score. However, in most cases, lenders will also want you to provide a personal guarantee, so they’ll want to check your personal credit as well. [Related article: How to Build Business Credit]

Minimum credit score requirements vary by lender but are typically between 660 and 680 for most conventional loans. However, many of the best business loans are available to borrowers with lower credit scores.

In addition to checking your credit, lenders will want to know how long you have been in business to assess your credit risk. To qualify for a commercial loan, you usually have to have been in business for at least one or two years. That way, the lender can be confident in your business’s revenue, which will be the primary source of repayment for your loan.

How commercial property loans differ from consumer loans

Commercial real estate loans are very different from individual (consumer) loans. These loans have very different requirements for collateralization and underwriting, as well as different rates, terms and other characteristics.

For one thing, there are far fewer programs for securitizing commercial loans compared with personal loans. This means lenders typically have to hold many of these loans after they’re issued rather than selling them off to investors, who assume the risk of loss if the borrower doesn’t repay the loan.

As a result, lenders are far more risk-averse when issuing commercial loans. The minimum credit score requirements are usually higher, as are the down payments. Mortgage insurance also isn’t an option for commercial loans, so income requirements and interest rates are generally higher.

In addition, commercial loans typically don’t last as long as consumer loans. Unlike home loans, which are commonly issued for terms of up to 30 years, commercial real estate loans often last only five or 10 years. However, loan amortizations can often be longer — up to 25 years is typical — leaving borrowers with balloon payments that they either have to pay off or refinance at the end of their loan.

Commercial real estate loan FAQs

Commercial loans are far more complex than conventional home loans, and there are a lot of details that confuse small business owners. To help, we’ve tried to clear up some of the biggest sources of confusion for borrowers. Here are answers to frequently asked questions about commercial real estate loans.

What’s the minimum down payment for a commercial real estate loan?

The minimum down payment required for most commercial real estate loans is typically 25 percent of the property purchase price (not including closing costs). However, down payments may be lower — as low as 15 percent if you use mezzanine financing in addition to a property loan or 10 percent if you use an SBA loan.

How long do commercial real estate loans last?

Commercial real estate loans typically don’t last longer than five or 10 years. However, loan amortizations can often be much longer — up to 25 years. While this means loan payments are much lower than if they had to be fully paid off in five or 10 years, it also means the borrowers will be left with a larger balance that’s due at the end of the term, at which time they will have to refinance that balance or pay it off in a lump sum.

Can you use an SBA 7(a) loan to buy real estate?

Technically, funds issued through the SBA’s 7(a) program can be used for real estate — to buy, build, renovate or expand. However, these loans are not designed for that purpose; for example, they aren’t collateralized by real estate. As a result, these loans are typically more expensive than other loan options, including SBA 504 loans.

What credit score is needed for an SBA loan?

Typically, qualifying for an SBA loan requires a minimum credit score of 660. For SBA 504 loans, the minimum is usually 680.

What are the interest rates for commercial real estate loans?

The current minimum interest rate for commercial real estate loans is roughly 6.9%. However, as with all loans, this rate will vary based on the prime rate that the Federal Reserve sets. Consider looking up the prime rate, then comparing several commercial real estate lenders’ interest rates to ensure you’re getting a fair deal. When rates are high and your purchase isn’t urgent, it may be smart to wait until rates fall.

Can you use working capital loans to buy commercial real estate?

Most working capital loan contracts include terms that forbid the use of loan proceeds toward commercial real estate. It’s best to pursue commercial real estate loans rather than alternatives so you can be confident your purchase meets your contract’s terms.

Buying the property your business needs

Just as you probably need a mortgage to buy a home, you likely need a loan to afford a commercial real estate purchase. If you meet all the criteria outlined in this guide, these loans are well worth pursuing. But even if you don’t meet all the requirements, go ahead and look at your options anyway — some lenders might offer more flexible terms. Put in the work, and that big commercial property your business needs might be right around the corner.

Max Freedman contributed to this article.