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Real estate that generates income but is used exclusively for commercial rather than residential purposes is referred to as commercial real estate (CRE). Retail malls, shopping centres, office buildings and complexes, and hotels are some examples of commercial real estate. Obtaining financing, which may include the purchase, development, and construction of these properties, is typically accomplished through the use of commercial real estate loans, also known as mortgages. These loans are secured by liens placed on the commercial property.
Commercial Real Estate Loan
When it comes to financing commercial real estate, banks and other independent lenders are just as active as they are when financing residential mortgages. Capital for commercial real estate is also provided by other entities, such as insurance companies, pension funds, private investors, and other programmes, such as the 504 Loan programme offered by the United States Small Business Administration (SBA).
In this article, we will examine commercial real estate loans, comparing them to residential real estate loans in terms of how they differ, their characteristics, and the criteria that lenders look for.
Residential Loans vs. Commercial Real Estate Loans
Commercial real estate loan
• Typically, business companies are the borrowers for loans on commercial real estate (corporations, developers, limited partnerships, funds and trusts)
• The tenure of a commercial loan is often between five years or less and twenty years, with the amortisation time frequently being longer than the term of the loan itself
• In the case of commercial loans, the loan-to-value ratio often falls somewhere in the region of 65 percent to 80 percent
Residential loans
• Individual borrowers make up the majority of the market for residential mortgages.
Home mortgages are a type of amortised loan in which the principal balance of the loan is paid back in equal monthly payments over the course of the loan’s term. The 30-year fixed-rate mortgage is the residential mortgage product that sees the largest demand from borrowers.
Certain residential mortgages, such as those offered by the USDA or the Veterans Affairs, permit extremely high loan-to-value ratios—even up to 100 percent.
Individuals vs Entities
Commercial real estate loans are frequently given to company entities, in contrast to residential real estate loans, which are more frequently given to individual borrowers (e.g., corporations, developers, limited partnerships, funds and trusts). The acquisition of commercial property is frequently the driving force behind the formation of these types of legal entities.
In the event that a particular entity does not have a financial track record or any credit rating, the lender may request that the principals or owners of the entity guarantee the loan. This supplies the lender with an individual (or group of individuals) who has a credit history and from whom they can recover in the event that the loan is not repaid as agreed upon. The debt is referred to as a non-recourse loan when the lender does not require this particular type of guarantee and the property is the only means of recovery in the event that the loan is not repaid as agreed. This indicates that the lender does not have any recourse against anyone or anything else other than the property.
Loan Repayments and Schedules
A residential mortgage is a type of amortised loan in which the debt is repaid in regular instalments over the course of a period of time. These payments are spread out over the life of the loan. Mortgages with terms of 25 and 15 years are two of the additional alternatives available to homebuyers in addition to the standard 30-year fixed-rate mortgage, which is by far the most popular type of residential mortgage product. When the loan’s amortisation period is shorter, the monthly payments are typically higher, but the total interest paid over the life of the loan is lower. On the other hand, when the loan’s amortisation period is longer, the monthly payments are typically lower but the total interest paid is higher.
The principal and interest on home mortgages are typically repaid in equal amounts over the course of the loan’s duration through a process known as amortisation.
Loan to Value Ratios
The loan-to-value ratio (LTV), which is a number that measures the value of a loan in comparison to the value of the property, is one more manner in which commercial and residential loans are distinct from one another. The loan-to-value ratio (LTV) of a property is determined by dividing the total amount of the loan by whichever of the property’s purchase price or appraised value is lower. For instance, the loan-to-value ratio (LTV) for a loan of $90,000 secured against a property worth $100,000 would be 90 percent ($90,000 divided by $100,000 equals 0.9, which is 90 percent).
Borrowers who have a lower loan-to-value ratio (LTV) will be eligible for more advantageous financing rates than borrowers whose LTVs are higher for both commercial and residential loans. The reason for this is that they have a greater equity share (or stake) in the property, which means that the lender perceives a lower level of risk associated with the transaction.
Certain residential mortgages are permitted to have high LTV ratios, including the following: It is permissible to have a loan-to-value ratio (LTV) of up to one hundred percent for VA and USDA loans, up to ninety-six and a half percent for FHA loans (loans that are insured by the Federal Housing Administration), and up to ninety-five percent for conventional loans (those guaranteed by Fannie Mae or Freddie Mac)
Commercial Real Estate Loan Interest Rates and Fees
The interest rates that are attached to commercial loans are often greater than the interest rates that are attached to residential loans. Additionally, there are typically additional fees associated with commercial real estate loans that contribute to the overall cost of the loan. These fees may include appraisal, legal, loan application, loan origination, and/or survey fees.
Some of the fees must be paid up front in order for the loan to be authorised (or disapproved), while others are assessed on a yearly basis. For instance, a loan could have a one-time loan origination cost of 1 percent, which would be due at the time of the closing, as well as an annual fee of one-quarter of one percent (0.25 percent), which would continue until the loan was paid in full. For instance, the loan origination cost on a $1 million loan might be 1 percent, which would be equal to $10,000, and the annual fee might be 0.25 percent, which would be $2,500. (in addition to interest).
Conclusion
In the case of commercial real estate, an investor (often a company organisation) will buy the property, then rent out space to businesses that will operate within the property, and finally receive rent from those firms. It is anticipated that the investment will be a property that generates revenue.Lenders consider the loan’s collateral, the creditworthiness of the entity (or principals/owners), which may include three to five years’ worth of financial statements and income tax returns, as well as various financial ratios, such as the loan-to-value ratio and the debt-service coverage ratio, when determining whether or not to make a loan for commercial real estate.
