Commercial real estate is property that businesses use to generate income. Examples include hotels, office buildings, shopping centers, and retail malls. Financing these properties includes funding a number of processes, including acquiring, developing, and/or even building them from the ground up, and businesses fund these projects with commercial mortgage loans, or liens that are secured by the property itself.

Banks, credit unions, and other lending entities, including private lenders, all play an active role in funding these kinds of projects involving commercial real estate. Such institutional investors as pension funds, insurance companies, and government-funded loan programs, also infuse capital into this market, providing commercial mortgage loans.

Understanding Commercial Mortgage Loans

In most cases, commercial real estate loans are extended to such business entities as developers, corporations, funds, trust, and/or limited partnerships. They have terms ranging from less than five years to 20 years. Since Canadian law restricts loan terms to ten years (and since ten-year loans in Canada often carry the highest interest rates), the amortization period is generally longer than the loan term. If you’re going to take out a commercial loan, you can expect the loan-to-value (LTV) ratio to max out around 80 per cent, meaning you can’t borrow more than 80 per cent of the appraised value of the project.

There are some differences between commercial mortgages and residential mortgages. In the residential market, individuals are most often the borrowers, not companies or organizations. The most common amortization period for residential mortgages is 30 years, or a decade longer than the longest amortization period for most commercial loans. In some cases, you can push the LTV ratio above 80 or even 85 per cent as long as you are willing to pay private mortgage insurance (PMI) premiums on top of your debt repayment.

Because commercial mortgages are extended to organizations and entities in many cases – entities that have been formed expressly to own commercial real estate – the due diligence differs from the residential mortgage process. Individuals have credit scores that make up an essential part of applying for residential mortgages. Businesses do have credit scores, but in many cases, entities applying for commercial mortgages do not yet have enough of a financial paper trail to have a meaningful credit rating yet. In those cases, the lender may mandate that the entity owners or principals guarantee the loan – and provide their own credit histories. In this case, those individuals would have to cover the debt should loan default happen.

One metric that lenders use when evaluating commercial mortgage applications is the debt-to-service coverage (DSCR) ratio. This compares the annual net operating income (NOI) of a property to its yearly debt service on the mortgage, including interest and principal. This ratio determines whether a property can generate enough income to pay for its debt. If a property with $280,000 in NOI and $200,000 in yearly mortgage debt service would yield a 1.4 DSCR ($280,000 / $200,000). If the DSCR is less than 1, the property has a negative cash flow. Most commercial lenders require a DSCR of 1.25 or higher to allow for fluctuations in the cash flow to happen without sending the cash flow into the red. If the amortization period is shorter or the property has a standing track record of stable cash flow, a DSCR between 1 and 1.25 may be acceptable. Properties with more uncertain cash flows, such as hotels, may require a DSCR higher than 1.25.

When you take out a commercial mortgage, you can expect interest rates that are higher than what residential loans bring. Fees for origination, loan application, legal costs, property appraisal, and/or required surveys can make the cost even higher, and some of the costs have to be settled up front before closing. Also, to protect the long-term return for the lender, some commercial loans come with a lockout provision that keeps the borrower from paying off the loan for a set period, such as three or five years. An interest guarantee entitles the lender to taking in a certain amount of interest even in cases of early prepayment. A loan might have a 12% interest rate guaranteed for 48 months, with a 3 per cent exit fee coming after that. All of these numbers will appear in the loan documents and, in most cases, are subject to negotiation.

Advantages of Commercial Mortgages for Businesses

  • Ownership of property. Renting a facility does not offer the stability that ownership does. Business owners can take advantage of property appreciation and the chance to leverage what they own for other financial advantages. With rent, you are just giving the landlord your money without drawing any of the potential benefits that ownership provides.
  • Lower interest rates than other business loans. Because the mortgage has your property as security, it generally comes with a lower interest rate than unsecured debt. Having fixed monthly mortgage payments makes predicting expenses easier.
  • Benefiting from capital gains. Property tends to appreciate over the long term, so betting on the value of the property you own to rise is wise. At the point of sale, you could re-invest the proceeds. You would face capital gains taxes at that point.
  • Renting part of the property out for revenue. If you own a property, then you can lease the parts that you do not need. Offices, storage space, and even parking spaces can all turn into revenue streams. When you are the renter, subletting part of your space out often requires express permission from the landlord.
  • Control over the building’s aesthetics. The way your business looks when people drive by or visit has much to do with your business’ reputation. If you are the owner of the building, then you can manage everything landscaping to exterior displays to interior decorating, and so you control the first impression that visitors make. If you are renting space, the landlord makes all of those decisions, and if upkeep and repair are not priorities for your landlord, your business is likely to suffer lost sales.

How to Qualify for a Commercial Mortgage

  • Satisfy owner-occupation requirements. In many cases, lenders require that the owner’s business occupies at least half of the building. Obviously, this will depend on the type of business.
  • Provide information about your business finances. This is where small businesses often run into difficulties securing funding as banks and credit unions view those entities as risky. The DSCR will be part of this calculation.
  • Pass the lender’s credit check. The lender will run your business’ credit report. If it doesn’t have one yet, then, as indicated above, the business owners or principals can expect to be asked to provide personal guarantees. Note that even with business credit, Personal Guarantees may still be required.

What if you don’t get approval from traditional lenders, such as banks and credit unions? Then you’ll want to learn about private money lenders for business. Private mortgage lenders generally base their loan decisions on the value of the property. Creditworthiness is still a consideration, but the value of the property is more important to private lenders than the borrower’s business or individual credit score. You can expect a higher interest rate this way, because you represent a higher degree of risk, but this is still better than not being able to get the funding in many cases.

In case you’re wondering, “How do private mortgage lenders work?” there are individuals and businesses that specialize in investing in real estate through loans to borrowers who can’t qualify through traditional means. They understand that not all credit scores are equal and that some businesses are simply not going to get traditional approval at first. The terms that private mortgage lenders offer is generally shorter, often a year or two, allowing individuals and businesses to spruce up their credit profiles so that they can qualify for traditional lending at the end of this term. Whether you need the sort of private lending Ontario and other provinces offer or not, understanding your options is essential to finding the right loan.

Comparing Lenders and Terms for Commercial Mortgages

Banks, credit unions, and lending institutions specializing in commercial real estate can all represent solid options. Take a look at the various interest rates that each lender offers, and then figure in the relative impact of the fees as well. Some lenders offer deals that have low interest rates but then build in fees to the fine print so they end up making more off the loan than a lender that just offers a rate, a handshake, and a quick direct deposit of funds.

Private money lenders for business can help you when you want to spend a year paying just the interest on a note, using what you would pay for principal go to satisfy other debts. You can use the time that you’re paying interest on that private loan to build up your credit score or other parts of your application so you can get approved by a traditional lender when this term expires. When you take advantage of the private lending Ontario and other provinces have, you can get started on owning your new business property and growing your enterprise much sooner.

Amansad Direct Lending Groups Primarily Assists with Residential, Land, and Small to Medium sized Commercial Mortgages. We have strong relationships and act for a variety of Private Lenders in the Form of Individuals, Mortgage Investment Corporations, Mortgage Investment Entities, and Approved Syndicate Referral Partners. Commercial Mortgages are rarely funded by a Single Individual due to the larger loan sizes. Much like Residential Mortgages; marketable Commercial Properties in Urban Markets are generally preferred with Personal Guarantees being a very common requirement.  It’s always suggested to explore Traditional Bank Financing options first before considering a Private Mortgage with our Private Lender Network.

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