Most brick and mortar business startups begin by leasing property. If the business is successful, then it might be wise to purchase property using a commercial real estate loan and save on leasing expenses. One lucrative strategy is to buy a block of spaces, such as with a strip mall, and use one or two spaces for the business and lease the remaining spaces for income. In these cases, the lender may require that the owner occupy at least 51% of the space to qualify for the commercial loan, otherwise, it may be considered an investment loan.
There are many reasons business owners purchase commercial real estate – expansion, inventory storage, upgrading the services offered and more. Whatever the reason, there is the first important step of getting qualified for a commercial real estate loan.
How to get qualified for a commercial real estate loan
Commercial loans are similar to a mortgage loan you would get for buying a home. There are different factors involved but the basic premise is similar. What is needed from the buyer will depend upon the lender and their requirements. Lenders will scrutinize a business owner more than a mortgage lender will scrutinize a home buyer, typically because there is more risk involved when lending to a business. As you prepare to apply for a loan, check to make sure you can meet the following general requirements.
- The property must be owner-occupied – owner occupies at least 51% of the space.
- Debt service coverage ratio of 1.25% or greater. (Calculated by Annual Net Operating Income divided by annual principal and interest on the loan.)
- FICO SBSS Credit Score of 140 or greater – score explained here. (There are exceptions for businesses that don’t meet this requirement.)
- The business is structured as a limited liability entity – LLC, LP, S, or C corporation (real estate loans to sole proprietorships are considered a personal loan.)
- Smaller companies may have to provide the credit scores of the business owners and/or partners.
- Maximum loan-to-value of 65% to 75% – the maximum amount that can be borrowed based on the property’s total value. The remaining percentage is the required down payment of the loan.
How to prepare for the application process
Applying for a commercial real estate loan is a long process. It’s a large investment and a risk for both you and the lender. The checklist below is what is generally required during the application process.
- State certification as a business entity
- Up to five years of tax returns
- A third-party appraisal of the property
- Business plan including planned use of the property and the expertise of management
- Financial records up to the last five years
- Projected cash flow report to cover the life of the loan
- Credit reports of all business owners and partners
Some loan programs may also require proof of citizenship for the owners.
If the business owner(s) has poor credit or the business is relatively new, it will be harder to qualify for a loan. If you are able to qualify, you may be facing much higher interest rates. This itself can be a catch 22 since it will increase the debt and payment, making an already difficult payment even worse.
If it seems you may not qualify, address as many of the following steps as possible to advance your case.
- Pay off as much of your business debt as possible.
- Apply for grants.
- Secure a financial partner or investor.
- Find someone to cosign the loan.
- Offer additional collateral.
- Prepare to pay a larger down payment.
- Consider finding a more affordable property.
If you don’t meet the requirements of a traditional commercial real estate loan, you can consider applying for a partially secured loan with the SBA.
Finding a qualified lender
Finding a lender is one of the most important steps. Banks, commercial lenders, and online lenders will have different fees, interest rates, and requirements. To start, talk to a commercial lender specialist. They can help guide you through the process and help compare your lender options.
At Affinity, our experienced lending team can provide funds for up to $25 million. Approval can be provided in as little as one day. Contact us for a free quote today!