How do commercial real estate loans work?
Commercial real estate loans are generally structured as term loans that you repay over a set period of time, with interest. Just as residential mortgages are secured by a lien on your house, commercial mortgages are typically secured by a lien on your commercial property.
To determine the amount of funding you’re eligible to receive for your business property loan, commercial real estate lenders use the loan-to-value ratio, or LTV. LTV is calculated by dividing the loan amount by the value of the commercial property you own or are looking to buy.
For example, say you have a commercial office space valued at $500,000 and a lender offers a $350,000 loan for you to buy the property.
$350,000 / $500,000 = 0.7, or 70%.
Commercial lenders usually will offer loan amounts with LTVs that range from 65% to 85%, depending on the type of property and your business’s qualifications, among other criteria. In general, the lower the LTV — and the higher the down payment you can offer — the better the interest rates you’ll be able to receive, as these factors indicate that you’ll pose less risk for the lender.
Commercial real estate loan terms and repayment
Repayment terms on commercial property loans can range anywhere from five to 25 years, depending on the type of property, your lender's business loan requirements and other factors. And unlike residential mortgage loans, commercial mortgages often have an amortization period that’s longer than the life of the loan.
For instance, a lender may offer a commercial property loan with a term of five years, but an amortization period of 10 years. In that case, you would make payments on the loan for five years, but the amount of each payment would be based on the loan being paid off over 10 years. At the end of the five-year period, you’d pay one final balloon payment to satisfy the remaining balance.
In other words, if you received a $500,000 loan with an interest rate of 5%, you would make monthly payments of $5,303.28 for five years, followed by a final balloon payment of $281,024.31 to pay off the debt.
Some small-business lenders, on the other hand, offer full amortization — which means the amortization period is the same length as the loan. At the end of the term, the loan is paid in full and there is no remaining balance that needs to be paid off in a balloon payment. The same $500,000 loan fully amortized over 10 years would require monthly payments of $5,303.28 over the 10-year term.
Commercial real estate loan rates and fees
Interest rates on commercial mortgage loans can also vary based on the lender, the type of loan, the value of the property you’re financing, and your business’s qualifications.
Anecdotally, interest rates range from 3% to 12%. And according to the National Association of Realtors’ 2019 Commercial Lending Report, the average interest rate on commercial property loans was 5% to 7%. Commercial mortgages tend to have more fees than other types of business loans. Commercial real estate lenders may charge origination fees, loan application fees, property appraisal fees, legal fees and other closing costs.
Where to get a commercial real estate loan
Banks and credit unions
Banks and credit unions typically offer conventional commercial mortgage loans — fixed- or variable-rate loans that are secured by your commercial property. These loans, available in amounts of up to $1 million or more, can be used to finance a variety of commercial real estate projects.
Commercial real estate loans from banks and credit unions will usually have the most competitive interest rates and repayment terms, but they’ll also be the most difficult to qualify for. Lenders will require that you have multiple years in business, excellent credit and strong business financials. You’ll likely be required to sign a personal guarantee as well.
As an alternative to a conventional commercial mortgage, you might work with an SBA lender (typically a bank or credit union) to get an SBA real estate loan. Both SBA 7(a) loans and SBA CDC/504 loans can be used as commercial real estate financing. SBA 7(a) loans can be used for a range of real estate-related purposes, with amounts available up to $5 million and repayment terms up to 25 years. SBA CDC/504 loans, on the other hand, are specifically designed for funding major fixed-asset purchases, such as buying real estate or renovating commercial property. These loans are also available in amounts up to $5 million (up to $5.5 million for some projects) with terms up to 25 years.
Both SBA 7(a) loans and SBA CDC/504 loans have competitive interest rates and may allow for down payments as low as 10%.
To qualify for either type of SBA loan, you’ll generally need a good personal credit score (690 or higher), strong business financials and at least two years in business.
In addition to local banks and SBA lenders, community development financial institutions, or CDFIs, sometimes offer commercial real estate products. CDFIs are private mission-oriented lending institutions that typically work with small businesses that don’t qualify for traditional bank financing. That means that while they may have higher rates or more stringent terms, they may be able to offer loans with little or no money down and accept lower credit scores than a bank.
Online lenders can offer access to commercial property loans with more flexible qualifications than bank or SBA loans. Some online business lenders will work with startups or business owners with less-than-perfect credit histories.
Many online lenders offer streamlined loan applications and quick funding — in some cases, within a few business days. Speed and flexibility come at a cost, however, as commercial real estate loans from online lenders will typically have higher interest rates and shorter repayment terms compared to bank or SBA loans.
Commercial real estate loan requirements
Most commercial loans from banks or traditional institutions factor your personal income, personal assets and credit score into their underwriting decision. Ideally, you should have minimal debt and a decent credit score before you think about applying for a commercial mortgage, as you would for a personal mortgage. At the very least, knowing what your personal financial situation is will help you going into the process.
Many lenders, including some that offer SBA financing, want to know that you have vested interest in a commercial real estate loan, and will ask for you to put a percentage of cash down. The LTV you’re eligible to receive will vary depending primarily on the lending institution and your business financials.
Time in business
Lenders want to make sure your business is somewhat established and trending up before granting something as high stakes as a commercial mortgage. Most require at least two years in business, but some want to see as many as four years.
Find and compare small-business loans
For a look beyond commercial real estate financing, check out NerdWallet’s list of best small-business loans, aimed at helping you make the right financing decision. Our recommendations are based on the market scope and track record of lenders, the needs of business owners, and an analysis of rates and other factors.