Before you begin shopping for a commercial real estate mortgage, you’ll have to address several issues to make sure your business is the right candidate. A trustworthy broker can help you determine if a commercial mortgage is right for you, but here are some of the questions you’ll need
Can I afford it?
While strong credit and a solid business plan are important to getting a commercial real estate mortgage, the most significant factor the lender looks for is your available cash flow. Lenders look at two key ratios to determine if you can consistently make timely payments - loan to value and debt service coverage.
The loan-to-value ratio (LTV) is the amount you wish to borrow divided by the appraised property value. For example, if you put 25% down and borrow the rest of the purchase price, your LTV is 0.75. The lower the ratio, the better candidate you are for lower interest rates.
Debt service coverage ratio (DSCR) is essentially a "financial cushion" that ensures your property will provide more income than you need to make monthly mortgage payments. Lenders determine your DSCR by dividing your net operating income (NOI) by your monthly interest and mortgage payments. Your DSCR needs to be at least 1.25 or higher to be considered at low risk for a loan.
How much money do I need to get started?
Typical commercial real estate mortgages start at $400,000 to $500,000 or more. To secure a mortgage of this size, your business will need to make a sizeable down payment. Commercial lenders generally require 20% to 30% down payments. Some lenders might accept 10% down if your other finances look strong, but you'll pay a higher interest rate in exchange. And unlike residential mortgages, you can't finance commercial property with "zero money down."
With a mortgage, cash troubles are especially dangerous because the building itself is the collateral for your loan. If you miss payments, or your DSCR falls below 1.25, the bank can foreclose on the building to recoup their losses. If buying a property means overextending your finances, you may want to continue leasing until your business is in a better cash position.
Is my Business Risky?
While commercial real estate mortgage lenders view apartment complexes and office buildings as relatively safe investments, riskier businesses like gas stations and new restaurants can be more difficult to fund. Such real estate purchases may require you to show a history of success running those kinds of businesses. You'll have to pay the lender for costly environmental tests and extensive research so the lender can determine if your business can succeed. And if you're approved for a loan for high-risk property, you'll likely pay a much higher interest rate. Make sure you understand the risks involved and that your business is equipped to overcome them.
How long a mortgage do I need?
The typical commercial real estate mortgage is 15 to 20 years. You can find mortgages as long as 30 years, which will lower your monthly payment. Of course, the longer you take to pay off the mortgage, the more you will pay in interest.
If you are in a strong position to pay off the mortgage within a few years, be aware of early repayment charges (ERC). Lenders may tack on costly additional payments if you pay off the mortgage early. An ERC can be a considerable unexpected expense, so if you discover that your lender has included one in the mortgage fine print, try to negotiate it out.
Key elements of a commercial real estate mortgage can get confusing. Learn how to avoid many of the misconceptions that commercial mortgage shoppers make.
for a mortgage:
- Evaluate your financials. The lender will consider the financial statements you provided, calculate your LTV and DSCR, and decide whether you demonstrate a high probability of being able to repay the loan consistently.
- Perform background checks. Lenders will review your business and personal history and credit to make sure your business is stable and can succeed in the new property. They will also appraise the value of the property and search the title history for any liens, verifying that the seller owns 100% of the property.
- Conduct environmental inspections. Depending on the potential health and danger risks of property, the lender may need to conduct environment inspections. Gas stations, industrial plants, and other businesses that work with potential harmful substances are subject to these inspections. These businesses are typically harder to fund and require more stringent lending policies.
- Approve or deny mortgage. Once all the evaluations are complete, the lender will either approve or reject your application. If they approve the mortgage, they’ll start preparing the mortgage documents. If they reject your application, they provide a list of reasons why, and you can try to fix those issues and reapply.
- Underwrite and fund loan. Once the loan is approved, the lender will underwrite the terms and conditions of the commercial property mortgage and arrange funding. Depending on the complexity of your business, this could take a couple of weeks or several months.
Once everything is agreed upon, make sure your lawyer reviews all of the fees and terms listed in the contract to check for inconsistencies. Once you and your lawyer have requested changes and reviewed the final documents, you hand in your down payment at the closing and sign the contracts. The money is typically available within a few days of finalizing the paperwork.