There are many different types of commercial real estate loans. It should be easy to say a commercial loan is any loan not secured by residential real estate. But, it isn’t quite true. There are properties called "mixed use" properties that have some commercial units and some residential units. So, except for mixed use properties, when we say "commercial" loan we mean anything not residential, oh, except for multi-family or apartment buildings.
Ok, so far so good. Now it gets even more interesting.
Over the years we have received many requests for a "commercial loan" and when we ask for a description of the property it turns out to be an "owner-user" property. That’s not a true commercial loan and normally requires an SBA (Small Business Administration) loan or similar type of loan from a local banker. Commercial lenders have a hard time analyzing that type of property because the income depends on the success of the owner’s business.
Then, there have been calls for a "commercial" loan and when we get to the details, the property is a gas station, or a church, or a funeral home, or some other special use property. Each has unique parameters.
Here is a list of the types of commercial loans according to one of our funding sources:
| Apartment / Multi-Family | Condo Conversion / Condotel | Gas Station / C-Store |
| Golf Course | Casino / Gaming | Health Care / Senior Housing |
| Hotel - Motel / Resort | Industrial / Warehouse | Land - Raw / Improved |
| Mobile Home Park | Office / Medical Building | Religious Facility / Non-Profit |
| Retail Anchored Center | Retail Unanchored Center | Self / Mini-Storage Facility |
| Single Tenant / Triple Net | Special Purpose | Mixed Use |
| Construction / Development | Bridge / Short Term | Mezzanine / Second T.D |
Almost without exception, the lender will be looking for strong cash flow and personal guarantees from the borrower.
We’ve been doing commercial loans for 22 years and have discovered some short cuts to analyzing how much money you can borrow on a commercial project. (Hint- It doesn’t have much to do with the price you are paying)
Here’s how the lenders really calculate how much they will loan you on a commercial loan. I’ll give you the formula and a side-by-side example. In my example I’m using a 100 unit apartment building with average rents of $1,200 a month.
Explanations are below the table.
| Step 1. Calculate gross annual income | 100 x 1,200 = $1,440,000 |
| Step 2. Deduct vacancy factor (5%) | = $1,368,000. |
| Step 3. Deduct expenses (30%) | = $957,000. |
| Step 4. Divide by 1.2 | = $798,000. |
| Step 5.Debt serviced at today’s rates | = $9,500,000. |
| Step 6. Maximum Loan | Lower of $9,500,000 OR 75% of value, |
Step 1 and 2 are easy.
Step 3 is usually a problem because every owner thinks they can run their building for less than 30% expenses but when you really analyze everything, that’s what it costs.
Step 4 is an interesting number. Lenders call it the "debt service coverage ratio". That’s just a fancy way of saying "this is just a fudge factor in case we calculated wrong". When a buyer or owner is making this calculation they never include a fudge factor because they know the building, they know the neighborhood, they know the market. But, just in case they are wrong, the lender will add this factor in.
Step 5 is just calculating the monthly cash available ($66,500) and asking the computer how much debt this will service.
Step 6 is one more "fudge factor" for the lender. They will not loan over a certain loan-to-value based on purchase price or appraised value. If you are lucky and your cash flow is strong, they will still only loan the LOWER of the above calculation or 75% of value. Many lenders will not even go over 65% or 70% of value.
A formula that works many times is 75% loan, 10% 2nd carried by the seller, 15% down from the buyer.
At first glance it may look like commercial properties are difficult, and sometimes they are, but commercial properties are usually a part of every strong investment portfolio. There must be a reason.
Our team would be happy to answer your commercial property financing questions. Simply use our contact form and write "commercial" in the comment section.
