Commercial Real Estate Financing

commercial real estate financing

Commercial real estate financing is the specific area of commercial business financing that provides business money for your business properties and investments. Some type of commercial property such as a strip mall, apartment building, hotel, bowling alley, or industrial building secures commercial real estate loans.

Commercial real estate loans consist of several distinct levels of financing, depending upon the stage of your project.

Commercial Construction Loans

If you are building or developing a new property, you will require some or all of these funding stages listed here. You may need a construction loan to build shopping mall or an office building. You want to make sure that you completed building is worth more when finished than it cost to construct it. This has usually been a given in the past. The normal increase in costs of materials and labor combined with the appreciation of real property almost guaranteed that a completed building would be worth more when completed than the original loan amount. However the recent real estate market will force you to be more cautious in the amount that you borrow. Many areas of the country are not experiencing stagnant or even decreases in property values. You want to plan your project to come out with around a 65% loan-to-value ratio (LTV). This gives you 35% equity and makes your commercial lender happy. Your finished property will have to generate enough income to qualify for permanent financing (a takeout loan) to pay off the original construction loan. This will be determined by the debt service coverage ratio, which should be at least 1.25. Debt service ratio is net income the property produces divided by the mortgage payment.

Mezzanine Loans

Mezzanine loans are similar to second mortgage loans except that a mezzanine loan is secured by the stock of your company instead of by the real estate. Why would you want to use this type of commercial real estate financing? There may be three different situations where you may find a mezzanine loan feasible.

First, suppose you own a valuable property worth $20 million. You owe $15 million on the first mortgage. You want to pull out some equity to take advantage of another business opportunity. Refinancing may not be an option. Your first mortgage may have a lock out clause or a huge prepayment penalty. A mezzanine loan would allow you to take out $2 – 3 million of your equity.

In the second situation you find an investment property that is run down with a high vacancy. You lender will only give you a $5 million loan but the purchase price is $10 million. You may be able to get another $4 million with a mezzanine loan. This will take you to a 90% LTV but your improvements and turnaround management will increase the property value to $12 million, which will reduce the LTV back to 75%.

The third way that you may use a mezzanine loan may be to close the gap what you can borrow in a construction loan and the total amount to fund the project. Say for example, you need $20 million to build a motel. You can get a loan for $12 million that leaves $8 million to come out of your pocket. You may be able to get a $3 million mezzanine loan, which will reduce your personal investment to $5 million.

You will notice that in all the examples for mezzanine loans the amounts discussed are in the multi-millions. Most lenders will not go through all of the paperwork required for this type of loan that is less than $2 million.

Commercial Real Estate Financing: Permanent Loan

A commercial real estate loan that is a first mortgage with a term longer than 5 years is called a permanent loan. A 10-year term is probably the longest you will find. You payment schedule will be amortized over 20, 25, or 30 years with a balloon payment at the end of the term. A take out loan is a loan that pays off a construction loan.

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