Securing funding for commercial real estate deals is an essential part of the process. Knowing the ins and outs of the various financing options available can make the difference between a successful deal and a failed one. In this blog post, we’ll discuss the fundamentals of financing commercial real estate deals and what you need to know to make an informed decision.
Commercial Financing vs Residential Financing
Regarding real estate investing, there is a significant difference between commercial and residential financing. Residential loans are typically assigned to individual borrowers, while commercial loans are typically granted to business entities. As for loan-to-value ratios, residential loans allow high loan-to-value ratios of up to 100%, while commercial loan-to-value ratios range between 65% – 80%. When it comes to the length of the loan, commercial loans range from 5 to 20 years, while the most popular residential loan is a 30-year fixed mortgage. Understanding the differences between commercial and residential real estate financing is important for any investor looking to get involved in real estate investing.
Types of Commercial Financing
Understanding commercial real estate financing basics requires knowledge of the different types of financing available to investors. There are many financing options for commercial property and construction projects, each with its unique requirements, benefits, and drawbacks. Here we will detail only a few options.
Bridge loans are a type of short-term real estate financing that can be used to cover cash flow gaps when financing is needed but not yet available. These loans are typically used when a company must repay one loan but hasn’t received the new, permanent loan yet. Bridge loans are typically for a short period, up to one year or less, and are not meant to be a long-term funding solution. Bridge loans can be used to cover the costs of purchasing a property, as you wait for another property to sell or for another type of capital influx to kick in, or to smooth over the refinancing process, as you wait for funds from your new loan to deposit.
Conventional Bank Loans are another option for real estate financing. These loans usually offer competitive interest rates and can be used for the purchase of a commercial building or the financing of any improvements or renovations. It often requires a larger down payment and has stricter credit requirements, as well as qualification requirements that vary based on the lender. Securing financing from a bank can be more difficult than other avenues.
Hard Money Loans are another type of commercial real estate financing that offers fast access to capital with minimal paperwork. These loans are backed by the property itself rather than by the borrower’s creditworthiness, making them a viable option for investors in need of a short-term solution.
Finally, Joint Venture Loans are another type of commercial real estate financing that can be used to fund larger projects. Joint venture loans involve two or more parties working together to finance a real estate project, often with one party taking a majority stake in the project. This type of financing can be an effective way to secure funding for larger projects without using personal assets or taking on debt.
Important Loan Ratios
When it comes to investing in commercial real estate, understanding the key loan ratios is essential. Two of the most important ratios are the Loan-To-Value-Ratio (LTV) and Debt-To-Service-Ratio (DSCR).
The Loan-To-Value-Ratio (LTV) is calculated by dividing the amount of the loan by its purchase price. Those with lower LTVs will generally qualify for better financing rates. The LTV ratio is also used to determine how much capital will be required from the investor. For example, the LTV for a $70,000 loan on a $100,000 property would be 70% since $70,000 ÷ $100,000 = 0.7.
The Debt-To-Service-Ratio (DSCR) is calculated by dividing the property’s annual net operating income (NOI) by its annual mortgage debt service. A DSCR of more than 1 indicates that the property has positive cash flow, while a DSCR below 1 means that the property has negative cash flow. When it comes to real estate financing, lenders usually seek a higher DSCR to ensure cash flow. For example, a property that has $100,000 in NOI and $70,000 in annual mortgage debt service would have a DSCR of 1.42 since $100,000 ÷ $70,000 = 1.42.
Investor Loan Source, a private money lending company, provides high-quality investment property loans to private real estate investors at the lowest costs possible. Our process for providing real estate investors with private lending is unique. We place emphasis on the hard asset and value of the collateral (property) and less on the borrower. Our asset-based real estate investment loan model means we can provide more money lending to more investors than is available from standard bank loan models. At Investor Loan Source, providing real estate investors hard money loans is our business; it’s all we do. We offer several business real estate loan products designed to serve a variety of investors and property profiles, including private money lending for properties to sell on owner finance.