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How to choose a commercial real estate loan

One of the best advantages of commercial real estate over other investments is the ability to operate it with financing, which increases your cash back and essentially, how well your money can work for you.

Consider the following example: you buy a property for $ 500,000 and put $ 150,000 on a mortgage, plus $ 15,000 in closing costs, for a total of $ 165,000. Once the rents are paid and the expenses paid, you have a cash flow of $ 36,000 per year. Your return on the money invested is almost 22% annually. If you have other cash on hand, this mortgage leverage allows you to invest in a second property or other opportunity, allowing you to grow your wealth faster and diversify your holdings.

However, financing is not guaranteed and the ease or difficulty of obtaining it varies depending on economic conditions. If you can or are willing to occupy your property as a residence or home for your business, you can take advantage of better financing terms that include less money, better interest rates, and more. amortization terms.

The following is a guide to the different types of commercial real estate loans available, whether you are buying a multi-family building, retail business, office, industrial building, or land.

Classic investment real estate loans

If you’re buying a multi-family, commercial, office, single-family, or industrial property as an investment with a conventional loan, you typically need to put 20-30% cash down as a down payment, depending on the lender. Conventional essentially means without special considerations or support from a federal government agency such as the Federal Housing Administration, Veterans Affairs or the US Department of Agriculture.

Unlike buying a primary residence, banks primarily use income from the investment property as their biggest barometer for whether or not to make a loan, but you will be required to make a personal guarantee. and they will assess your personal finances as such. . A personal guarantee means that you are personally responsible for paying for the ticket, even if you used an entity or company to purchase the property (and that entity is the ticket holder).

Conventional commercial loans are generally shorter term notes than residential mortgage rates with fluctuating interest rates. For example, you can get a conventional 5.5% business loan for three years, after which it will skyrocket, which means you will technically have to pay it off or refinance it. As long as things go well, the bank will agree to continue to hold the mortgage but will reset the interest rate at that time to current rates.

While residential mortgages are often amortized over 30 years, commercial mortgages typically do not exceed 25 years, and most often around 20 years. The amortization period of a bank depends largely on its policies, the attractiveness of the operation and your relationship with the bank.

FHA will support purchase or refinance multi-family properties with five or more units if they meet certain qualifications, such as:

  • Each unit has a full kitchen and a bathroom.
  • The property has undergone a major rehabilitation with a minimum of three years prior to the date of the mortgage application (this allows you to make non-critical repairs within one year of the loan closing).

This program can be great because it will offer higher loan amounts than a conventional loan and higher loan terms with fixed rates (up to 35 years), and also applies to for-profit borrowers and non-profit. For apartment buildings at market rates, the FHA will lend 83.3% of the value, and up to 90% for certain other projects, such as projects that meet the HUD Definition of Affordable Housing, and section 202, which deals with housing for low-income seniors.

To get started with the program, you need to get in touch with a HUD Center near the location of the property.

This type of loan allows the new construction or the substantial rehabilitation of apartments intended mainly for the disabled, the elderly and low-income families. Terms are up to 40 years from lenders approved by HUD.

The project must contain five or more units, but can be detached (such as houses that are all part of the same community on the same street), apartments, semi-detached or co-ops.

If you are planning to acquire an apartment building in one of the urban renewal, code enforcement or revitalization areas, you can get the FHA Section 220 loan to build it or rehabilitate it. The project must consist of two or more units, and the maximum loan amount is 90% of the cost of repairs and reclamation and the value of the property before reclamation.

Like Article 221, the maximum loan term is the lesser of 40 years or 75% of the economic life of the project.

To determine eligibility for this program, you can consult the census tract for your future property and cross it with the list of HUD revitalization zones.

Loans between individuals or private investment real estate loans

Certain real estate transactions, such as repair-and-return or other distressed properties, are difficult to finance through traditional banks because they are inherently risky. This is where equals, private or hard money lenders can be a good resource for financing commercial real estate investments.

Private lenders often charge a set-up fee and higher interest rates, depending on the borrower’s level of experience and the promise of the deal. Private loans are often for shorter terms, like three years or less, but are amortized over 25 or 30 years, just like with a traditional bank. If the property needs work, you can use a private cash loan to finance development and construction and later refinance it to a conventional loan, once the asset is stabilized and less risky in the eyes of the traditional bank. .

Owner-occupied financing

You can benefit from advantageous financing conditions if you plan to live or occupy your business in your commercial building.

The best thing about this scenario is its ability to get your foot in the real estate investing industry with less money, before you use your cash flow to move into the next property, and the next.

Even if you sold the first owner-occupied property, you can keep the financing for the property and also get the financing for the next one. Ask your bank about their specific timing requirements for property transactions. You may have to agree to occupy for three years or more.

Apartments

If you’re hoping to start by owning a multi-family building or apartment building, you could live in one of up to four units to get Owner-occupied FHA financing.

These loans have low interest rates and require you to deposit as little as 3%. The rate limits vary, but are just over $ 725,000 in expensive markets. You can even use most of the rental income from other units to help qualify for the loan. The FHA requirements and process allow people with lower credit scores or poor credit problems to obtain loans. The minimum credit score to qualify for a 3.5% wager is 580. Anything between 500 and 579 requires a 10% wager.

You will need to pay a mortgage loan insurance premium up front, which is 1.75% of the loan amount paid at closing. It can be funded. Then there’s an annual mortgage insurance premium ranging from about half a point to one point, depending on whether your loan term is 15 or 30 years. To cancel them or stop paying the premiums, you will need to refinance or sell your home.

The FHA has a 203 (k) loan program which allows homeowners to renovate the property with bank funds. A limited version of the program allows improvements of $ 35,000 or less, while the standard program is a bit more onerous in terms of the application process, but the property total must still meet the FHA mortgage limit for your area. purchase.

Find an FHA Approved Lender on HUD.gov.