For those who are just getting their feet wet in the world of commercial real estate investments, it can be overwhelming to realize how much there is to learn. Commercial real estate loans, or CRE loans, can be quite different from residential mortgages in many respects. From the qualification requirements set by lenders to the terms of the loans themselves, it is advisable to take the time upfront to get comfortable with the terminology and logistics of buying and selling commercial properties.
Who Obtains Commercial Real Estate Loans?
Commercial real estate loans are typically obtained by businesses, not individuals. Even if you intend to be a solo investor, it is advisable to establish a business entity for the purpose of keeping your personal finances separate from your business interests. Consult with an accountant and an attorney to determine which sort of small business structure is best suited to your plans for commercial real estate investment.
Who Finances CRE Loans?
CRE loans are financed by banks, credit unions, alternative lenders and other sources, including a program administered by the Small Business Association. Lenders will want to examine your financial statements and tax returns in order to assess your creditworthiness for a loan. Lenders will also check out two financial ratios in particular that are related to the property you want to purchase.
The first ratio they will consider is the loan-to-value (LTV) ratio. You may have heard this term used in residential mortgages, and it is used the same way in commercial real estate. However, while a residential mortgage may have an LTV of 80% or even higher, commercial real estate loans top out at 80% LTV. In fact, many loans have an LTV in the range of 50-60%. LTV refers to the amount of money for which you need a loan, divided by the selling price of the property.
The second ratio lenders will consider in CRE loans is the debt service coverage ratio (DSCR), which is used for income-generating property such as commercial real estate. To calculate DSCR, you will need to know the annual net operating income of the property, which is the gross rental income less operating expenses. Divide the net operating income of the property by the annual cost to service your CRE loan. The result should be greater than 1, or else your property will have a negative cash flow and be a poor investment. Lenders will look for a DSCR of 1.15 to 1.35.
Learning More About CRE Loans
While CRE loans can sound rather intimidating at first, it takes minimal research to acquire a basic grasp of how they work. Doing so will help give you a leg up when it is time to begin moving forward with the actual purchase of your chosen property. To Learn more about Commercial Real Estate loans, contact Bull Marketing Business Funding Solutions today!