Commercial Real Estate Loans: How to Get a Mortgage for Your Business
Commercial real estate loans can improve and enhance your business.
The majority of mortgage loans are made to individuals and couples purchasing their personal residence. Most people understand these loans, or at least have a general picture for how they operate and how they are issued.
But what about loans made to businesses seeking commercial real estate? What if your growing business needs to expand from your garage to a real office, and you’re not interest in renting a space?
In this case, there are mortgages available. But as you’ll learn, commercial real estate loans come with higher standards and a more meticulous application process. By preparing the appropriate documents and organizing your business, you can be fully prepared to make the right decision.
How to Get Commercial Real Estate Loans
For this article, we are not talking about loans for purchasing an investment property. In this case, we are talking about businesses that will use the property for the business. We are discussing an electrician, for example who needs a bigger shop, so they purchase a commercial property. We are discussing retail owners who want to own their storefront. We are not talking about an investor who purchases a commercial property then leases out the space to a business. This is an important distinction, although the loans often have similar characteristics.
Individual or Entity?
Residential loans are generally made to individuals or couples. Unless it’s an investment property, loans for single-family homes are not made to corporations, LLCs, developers, and other entities. In these cases, the buyers are looking for commercial property.
However, an entity may not have a financial track record that makes it suitable for borrowing. Just like people, an entity needs to establish its creditworthiness over a long period, proving that it can successfully handle a large mortgage. If the entity does not have this credit history, it may be harder to get an affordable loan; in this case you may need to consider taking a loan as an individual to purchase the property. Another option is to have an individual guarantee the loan. This basically means that if the loan is not repaid by the entity they agree to be held financially responsible.
What Lenders Want to See When Approving Commercial Real Estate Loans
Business loans have a lot of risk, more so than a typical mortgage for an owner-occupied residential property. Many businesses don’t succeed, and lenders are well aware of this fact. In order to reduce risk, these loans come with more scrutiny than residential loans, but you can prepare for this scrutiny by organizing documents that outline your business’s financial picture.
For businesses, lenders often look at a system called the debt-service coverage ratio, which functions in much the same way as an individual’s debt-to-income ratio. Essentially, this is a calculation of your business’s annual net operating income divided by your annual total debt service, which is the amount you spend on paying back loans.
The lender will also look into the business’s credit profile to gauge how likely your company will be to repay a loan. Business credit uses a system called SBSS, for “Small Business Scoring Score,” a redundantly-named calculation that is used in many business loans, including loans serviced by the Small Business Administration. This score ranges from 0 to 300, and your business will generally need a score of at least 140, although this requirement can go to 180 or higher depending on the lender and the nature of the loan.
While the loans will likely be issued to the entity in question, banks and commercial lenders will often look into the personal finances and credit profile of any and all owners. Personal credit scores and repayment histories will need to be offered to the lender, and you’ll need to show that you have not had any personal negative marks on your credit history. If you or another owner has had any tax liens, court judgements, foreclosures, or loan defaults, it can significantly reduce your chances of securing a mortgage loan for your business. If any of these financial problems occurred in the recent past, it will carry more weight. For example, if an owner went through a foreclosure in the past two years (give or take), it could create difficulty for your application.
Regardless of score or credit history, you should always meet with a qualified lending agent, especially one with access to a variety of loan options.
Ownership of the Business
This may seem obvious, but in business things can be complicated, and percentages of ownership can be a factor when issuing a loan. To qualify for a loan on the property, you will likely need to show that you own at least 51% of the business or you will need to have your business partners involved in the transaction. (In general, it’s wise to include your business partners regardless of ownership percentages.)
How to Prepare Your Application for a Commercial Real Estate Loan
The start-to-finish process of applying for a loan and getting approval for the purchase can take months, so it’s best to start the process as soon as possible.
To fully prepare for your application, you should prepare the following documents:
- Financial Records: Banks will want to see as much financial information as possible, so prepare your financial records and reports before meeting with a lending agent. This should include off-balance-sheet financing, such as leases, as well as books and financial reports. Generally, you’ll need five years of information. If your business is younger than that, say two years, bring information dating back to the company’s inception.
- Tax Returns: Businesses have tax information just like a personal citizen, and lenders will want to see this information to verify your finances. Just to be prepared, you should also bring tax returns on individual owners; the bank may not request them, but having them ready will not hurt your chances of approval.
Enhance Your Business with Affordable Commercial Real Estate Loans
With an affordable commercial real estate loan, you can reduce costs and potentially enhance the profitability of your business, all while giving your team a functional space.
Contact our staff today to learn more about commercial real estate loans.