Some Types of Commercial Real Estate To Invest In
Commercial real estate (CRE) is potentially one of the more profitable investments which can be made. There are many advantages created by these income-producing investments over residential investments, they can not only generate monthly income through reoccurring rental cash flow, but they are also a great way for building wealth.
Types Of Commercial Real Estate
There are various types of commercial real estate, many used for business purposes, with owners leasing the occupied space for monthly rent. Commercial real estate normally consists of the following property types:
- These commercial properties consist of the apartment “four-plexus,” high-rise condominium units, and smaller multi-family units, which can range from four to 100 units. Unlike other forms of commercial real estate, the lease terms on multi-family buildings are typically shorter than office and retail properties.
Office space is the most popular type of commercial real estate is office space. They range from single-tenant offices to skyscrapers are broken down into one of three categories: Class A, Class B, or Class C.
- Class A commercial real estate properties are typically newly built or extensively renovated buildings in excellent areas with easy access to major amenities, typically professionally managed.
- Class B commercial real estate properties are frequently older buildings requiring capital investment, to upgrade the building and property. These are usually a popular target for investors.
- Class C commercial real estate properties are typically used for redevelopment opportunities. They are generally poorly located, require major capital investments to improve out-of-date infrastructure, and their high vacancy rates are much higher than higher-classed buildings.
Also popular, retail buildings are properties, ranging from strip centers, malls, community retail centers, banks, and restaurants, which are often located in urban areas. These properties may range in size from 5,000 square feet to 350,000 square feet.
From warehouses to large manufacturing sites, and industrial parks, industrial buildings are typically manufacturing industries, warehouses as they offer spaces with height specifications and docking availability. Also, these commercial properties generally lend themselves more to investment opportunities.
Unlike the properties mentioned above, special purpose commercial real estate properties are constructed by the investor. They typically consist of car washes, self-storage facilities, and even churches.
Because the best commercial real estate properties are in high demand, investors must focus on location, future development, and improvements. Resulting in these properties increasing in value and a greater return on investment.
Commercial Real Estate Interest Rates & Fees
Unlike residential loans, the interest rates on commercial real estate loans are normally a little higher. Several fees attribute to the overall cost of commercial real estate loans, including appraisal, legal, environmental studies, application, origination, potential zoning changes, and survey, or engineering fees. While some of these are subject to the particular deal, some fees apply annually, others must be paid upfront even before the loan is approved.
Commercial Real Estate Loan Prepayment
Sometimes, a commercial real estate loan may have prepayment restrictions. These restrictions are designed to preserve the lender’s anticipated yield. Investors can settle the debt even before the commercial property investment loan’s maturity date. If they do so, there may be prepayment penalties.
How To Get Commercial Investment Property Loan
The idea of obtaining commercial real estate financing may seem intimidating at first. Investors who educate themselves about the process and the various types of commercial real estate loans discover they are very attainable. The following are the key steps involved in obtaining a commercial investment property loan:
- Determine whether you will file as an individual or an entity.
- Evaluate mortgage options and determine which loans will work best for your specific property and exit strategy.
- Calculate LTV to measure the value of the loan to the value of the property.
- Determine the ability of the project to service the debt by using the debt service coverage ratio.
Types Of Commercial Real Estate Loans
There are many types of commercial investment, and the investor and their advisors determine which financing option best fits their needs and strategy. Each loan type will have its unique eligibility requirements, down payment necessary, minimum credit score, and experience level. These loans also have varying terms to focus your attention on, including the loan term, interest rate, and loan-to-value (LTV) ratio.
The following are some of the commercial real estate loans which may meet your specific goals:
Small Business Administration (SBA) 7(a) Loans
The U.S. Small Business Administration offers several loans under the 7(a) umbrella, each of which is designed to provide financial assistance for small businesses. Investors looking for commercial real estate loans should carefully consider which of the following 7(a) Loans will work best for their next project:
Certified Development Company (CDC) / SBA 504 Loan
The 504 Loan Program is another SBA product made available through Certified Development Companies (CDC). These loans are specifically intended to stimulate business growth and job creation by offering small businesses yet another financing avenue. More specifically, however, the “504 Loan Program provides approved small businesses with long-term, fixed-rate financing used to acquire fixed assets for expansion or modernization,” according to the SBA.
Also known as traditional loans, conventional commercial real estate loans are issued by banks or lending institutions. Consequently, conventional commercial real estate loans are not backed by the federal government. Often used to purchase and finance assets like owner-occupied office buildings, retail centers, shopping centers, and industrial warehouses, conventional loans have developed a reputation for some of today’s most widely used commercial real estate loans.
A traditional commercial property loan typically finances anywhere from 65% — 85% of an asset’s loan-to-value ratio. As a result, borrowers will often be expected to cover anywhere from 15% — 35% of the property’s fair market value/purchase price. That said, there is usually no loan maximum. Borrowers can, however, expect commercial real estate loan terms to last anywhere from 5 — 20 years, with payments fully amortized over the loan’s duration. While conventional loans tend to come with lower fees, they are often harder to receive approval for.
Commercial Bridge Loan
As their names suggest, commercial bridge loans represent a temporary loan option for investors to exercise—one that bridges the gap—until refinancing becomes available to make the switch to a longer-term loan. Typically offered by institutionalized lenders, commercial bridge loans award many borrowers the ability to compete with all-cash buyers. Since commercial bridge loans usually finance up to 90% of a property’s LTV, those who can’t use cash should find it easier to get their foot in the commercial real estate sector. Since bridge loans are short-term, they don’t tend to last longer than three years. Therefore, borrowers should expect to refinance to a long-term loan sometime shortly.
Hard Money Loan
A hard money loan is made available to commercial investors by organized semi-institutionalized lenders. More importantly, however, hard money lenders are typically licensed to lend to real estate investors and specialize in short-term high-rate loans with fees that award many investors the chance to buy commercial real estate that they wouldn’t be able to otherwise.
In return for roughly 60% — 75% of the asset’s after repair value (ARV), hard money lenders will require interest fees upwards of 15%, in addition to about four points (another upfront percentage fee based on the loan amount). While hard money lender fees are sometimes as much as four times that of traditional lenders, they may be well worth the cost of admission for short-term loans. Not only is funding granted within a few days (as opposed to months with traditional lenders), but it can be a lot easier to receive approval for. If, for nothing else, hard money loans are asset-based, meaning the lender makes a decision based on the subject property and not entirely on the borrower.
Otherwise known as commercial mortgage-backed securities (CMBS), conduit loans are commercial real estate loans secured by a first-position mortgage on a commercial property. Conduit loans are traditionally offered to borrowers through commercial banks; conduit loans offer borrowers a fixed interest rate over 25 — 30 years. However, it is important to note that conduit loans will require a balloon payment at the end of the term. Thanks primarily to their relative flexibility, conduit loans allow many commercial real estate investors to qualify for a loan that typically wouldn’t.
Life insurance providers, or conglomerate companies, offer commercial real estate loans where the borrower’s line of credit is secured with a first lien position on the property. These loans are typically only used by strong borrowers who have an excellent credit history. Further, they are best used on newer properties, or those deemed less risky for the borrower. Most providers will favor industrial, office, retail and apartments though investors may still find success funding a mixed-use property with an insurance loan.
To truly understand how to invest in commercial real estate, investors need to fully comprehend the financial components that go along with it. Commercial investment property loans are nothing short of instrumental in the success or failure of a particular exit strategy. Therefore, take the time to review the commercial real estate financing process or consult an expert before getting involved in the process, including the various loans made available to you and everything else that will affect the success of the project.