Real estate investing is all about leverage. This is the best way to develop and extend an investment portfolio. Whether with money from the capital partner, often called other people’s money (OPM), or bank financing, being able to buy an income-producing asset for only a fraction of the value is a game-changer.
Real estate investors involved in several families, Office, retail, and other business investments will be familiar with business loans. It is the section of the mortgage industry that manages these types of assets. And there are crucial distinctions between this industry and the residential lending side of real estate.
Business loans vs residential loans
The biggest benefit to understanding commercial real estate loans is how much it differs from residential. Here are some of the ways.
Types of assets
A commercial real estate loan usually comes into effect when you are dealing with a business such as a retail store, restaurant, office, etc. Following. In this case, a duplex, triplex, or quadruple usually does not qualify for a business loan.
Nowhere are the two loan products more different than in how they value the underlying asset. A home loan will value the property primarily on the basis of comparables; that is, what did a similar property in a similar neighborhood sell for? Comps give you the approximate value of your residential asset. Commercially, the asset is treated more like a business than a comparison to a similar property. Typical commercial loan appraisals are performed using capitalization rate (cap rate) as good as net operating income (NOI) of the property.
For example, if you have a 10-unit multi-family building with an NOI of $ 120,000 and a local capitalization rate of 6%, the value of your building will be $ 2 million ($ 120,000 divided by 0.06) . This approach is not used on the residential side.
Types of business loans
As with any set of loan products, business loans come in many shapes and sizes. Here are the top ones real estate investors should know.
Conventional business loans
Similar to the residential side, a conventional commercial real estate loan will have an amortization schedule of 20 to 30 years at a fixed rate. interest rate. the loan-to-value ratio (LTV) for conventional commercial loans is 80%, with investors having to pay the remaining 20% as a down payment. This type of loan will not include working capital for any type of construction or rehabilitation.
As the name suggests, an advertisement ready to build can be obtained for the new construction of a commercial property or a multi-family building (five or more units). This is usually a shorter amortization, perhaps one to two years depending on the schedule, and will be refinanced when construction is completed using a conventional loan.
This type of business loan will require certain milestones to be secured before more funds, called drawdowns, are provided to the builder. Commercial construction loans also generally have higher interest rates.
Commercial loans can often have what is called a balloon payment, while on the residential side it is rare. A lump sum payment is usually made when interest only payments are made during a certain period and a lump sum is due on a specific date. This differs from a typical home loan, where the loan payments are a combination of interest and principal.
you will see much more seller financing in commercial credit than in residential. Seller financing is typically received when the seller of a commercial property “takes back” part of the down payment as a second mortgage. For example, on the sale of an office building, the buyer can pay 10%, the seller 10%, and the bank finances the remaining 80%.
In this case, the seller would register a second mortgage with the 80% commercial real estate lender. The reason for the increase in seller funding on the commercial side is that there is a smaller pool of buyers and sellers are willing to be more creative in offloading inventory.
Sometimes in commercial loans a homeowner will need capital for a short time to “bridge the gap”. two different loan scenarios. For example, between a construction loan and a conventional loan, a bridging business loan may be needed from a commercial lender to help the owner better position or stabilize the asset. Bridge loans typically last six to 24 months and carry a higher interest rate because qualifying is easier – and therefore riskier – than applying for a traditional mortgage.