The Foundations of Commercial Real Estate Financing

By Venture Mortgage Corporation

Are you considering the purchase of your first commercial real estate property? It’s an attractive proposition: the first rule of building wealth is to increase assets and limit liabilities, and income-generating real estate, properly managed, will add to one’s net worth and increase one’s economic security. However, it is important to be a well-informed investor, and there are some key considerations that are especially vital for first-time commercial property buyers to understand. In the first segment of this series, we will begin to understand the wide world of commercial real estate financing.

1)      Understand property types: What type of property are you pondering? For many first time buyers, multifamily rentals are the default choice, as they are familiar with residential property as renters and/or homeowners. It could be that office, industrial, or retail properties are a better fit for your goals and career experience, but do keep in mind that the cost of acquisition for these property types are often significantly higher than the multifamily sector. Commercial properties are generally divided into five general categories: retail, office, multi-family, industrial, and special use (land and land development are a separate phenomenon that beyond of the scope of this writing). Within these categories, properties are further divided based on location and condition. The type and classification of the property you decide to buy is a very important consideration when it comes to obtaining financing and in calculating potential return on investment. Speaking of financing…
2)      Commercial real estate financing is potentially quite complex : Most commercial real estate buyers are familiar with the process of obtaining a residential mortgage, but financing a commercial real estate property is generally very involved and can be intimidating to first time investors. The loan origination process is unique to each property and buyer, and there are many lending sources, each with its own advantages and disadvantages. Investors should expect to come to the table with at least 20% down for the majority of properties, as lenders are generally not willing to go over an 80% loan-to-value (the ratio of the outstanding debt to the value of the property). This means that, for a $1,000,000 property, one should be prepared with a minimum of $200,000 toward the purchase. Appraisals are usually required, as well as a number of other third-party inspections and reports as a part of due diligence: these typically include environmental reports, title searches, an American Land Title Association (ALTA) survey, and more as requested by the lender. These third party reports, combined with loan fees and legal costs, can add up to thousands of dollars very quickly. Lenders consider a wide array of factors when they underwrite loans: for example, a particularly risk-averse lender may be uncomfortable lending on an 80 unit apartment building to a first-time borrower with no property management experience, even if said borrower comes with a considerable down payment. This is why it is vital to…
3)      Know your lending options: Did you know that you can borrow money from a life insurance company to purchase an office building? How can you tell which bank is best for a property in a secondary market? Do credit unions even do commercial real estate loans? How do you know if the rate you’re being quoted is a good one? Which lender is the best choice for me and my situation? There are ways to answer these questions and make informed decisions. A commercial real estate mortgage banking firm is a company that has established relationships with a wide variety of capital sources for the purpose of securing commercial real estate financing for borrowers. By shopping an investment to life insurance companies, banks, credit unions, agencies, and commercial mortgage backed securities (CMBS) lenders, the firm is able to inform the investor about the options available, simplify the origination process, and secure the most favorable rates and terms for the client. In some cases, such as with life insurance company lenders, loans are only available through commercial real estate banking firms (which will act as a conduit); by not consulting with a mortgage banker, borrowers are potentially excluding lenders who will offer the best available loan package. A consultation with an experienced mortgage banker at Venture Mortgage regarding a potential purchase is always complimentary. In fact, Venture Mortgage is only paid a fee if we secure financing and close a loan for you on your terms, and our many satisfied clients speak not only to the savings they realize with us, but also to the superior service they receive during the origination process and throughout the life of their loans.

In the upcoming segments, we will take a closer look at the loan approval process and answer the question, “What Are Lenders Looking For?”

We will also begin to the understand the fundamentals of the different property classes in “Property Types: How Commercial Real Estate is Defined and What It Means For Financing”.