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What You Need to Know About Commercial Property Financing
Obtaining a business real estate advance is a lot more difficult than getting a home advance, and you need to be prepared for a grueling process that has many twists and turns – and sometimes a surprise ending.
If you’ve never applied for a business advance before, you may be surprised by how picky commercial lenders can be. And then you have to consider how risky the process can be for you personally. In the event that your commercial lender turns you down at the last minute after the wheels have already started to turn, you might even have to declare bankruptcy.
You’ll need to pay appraisal fees and toxic report costs, and these don’t come cheap. If you are turned down and need to start a new application, you may have to pay for all of these third-party reports again. To make the game even riskier, there are many impostors masquerading as direct commercial lenders, and they are only interested in ripping you off to collect the exorbitant application fees.
In order to avoid a series of missteps that could land you in hot water, it’s best to understand the specific steps of obtaining a business real estate loan before you start looking for a suitable lender.
Firstly, it’s important to understand one of the fundamental differences between commercial property loans and residential mortgages. While home loans are typically backed by a government entity like Fannie Mae or Freddie Mac, loans for business properties are not.
As a result, the lenders charge higher interest rates and are hungry for lots of assurance.
Some lenders will go so far as to evaluate the borrower’s business model, as well as the commercial building that will serve as collateral. Don’t go into a commercial real estate lender’s office with the same expectations as you would when you’re applying for an advance secured against your primary residence. It’s a different ball game.
Meeting The Loan Repayment Terms
In the world of business real estate financing, lenders expect the borrower to repay the entire business advance earlier than the due date. They do this by including a balloon repayment stipulation. This means that the borrower pays on his 30-year mortgage as usual for a few years with principal and interest payments, and then he ll have to pay off the entire balance in one fell swoop, or one balloon payment.
But a balloon loan could be a recipe for disaster, especially if the borrower is not ready when the balloon payment comes due (usually after 3, 5, or 10 years). If this is the case, the borrower must refinance the advance. Remember that the lender is keeping one eye on the borrower’s business and cash flow. If it appears to the lender that the business is not doing well in the years leading up to the balloon payment, the lender may jack up the interest rate or flat out refuse to refinance. The prospect of the realty going into foreclosure is always a concern with balloon loans.
How Long Does It Take?
You should receive a preliminary answer or pre-approval the same day or the next business day, but this doesn’t guarantee that your loan will be approved. The lender needs 10 to 20 additional business days to run detailed financial reports and in-depth credit checks.
The loan is then scrutinized by underwriters, and these are seriously picky people. They want to meet you (and sometimes your business associates) before deciding if they should lend you money. Once the loan application has gained the approval of the underwriter, you just hammer out the terms and sign on the dotted line. Although many lenders boast that they can push a business loan through in 45 days or less, it usually takes closer to three months.
The Required Documents
Even before you apply for the advance, inquire about the necessary documentation. Some small businesses lack the kind of income documentation required for business lending, so it would be a waste of time to start the process in the face of insurmountable roadblocks.
Business property financiers need to see the last 3 to 5 years of tax returns and financial statements, including:
- Corporate documents
- Asset statements
- Personal financial records
The more documentation required, the longer the advance approval process will take.
Watch Out For Hidden Costs
Don’t be fooled by a low interest rate if there are too many fees involved, including but not limited to legal fees, application fees, appraisal fees, and survey charges. It may seem confusing at times, but remember that points are percentages that the lender pockets off the top. If your interest rate is 9 percent with two points, the real cost of borrowing the money is 11 percent.
In some instances, these charges and hidden fees can add up to tens of thousands of dollars, so you need to find out if it’s likely you’ll be approved before you drop a small fortune on the application fees.
Banks vs. Non-Bank Lenders
Non-bank lenders (such as silent investors, for example) are usually less strict about their eligibility requirements, and many are willing to loan you money without including the early balloon repayment stipulation. In reality, these loans are just like home advances in that they offer you a steady repayment plan spread out over 20 or 30 years. However, they do carry slightly higher interest rates.
There are some other disadvantages to non-bank commercial property borrowing, namely the high expectations of the lender. If you don’t generate an anticipated profit, a nervous private lender may pull the plug on your funding. Until he sees a return on his investment, he may even start taking possession of items you posted as collateral.
The obvious advantage of obtaining your loan through a traditional bank is the rigorous reporting system it offers. If you make all your payments on time, your bank reports will reflect that. In turn, this will increase your credit rating and make it easier for you to qualify for loans in the future.
Top Tips For Business Property Borrowers
Here are the top tips for getting the most out of your commercial property loan:
1. Shop Around
Don’t rely on a single commercial lender. Instead, contact at least three different lenders. business lending is very subjective, meaning your eligibility is determined by someone who may or may not be fair. The more options you have, including both banks and non-bank lenders, the more likely you are to get approved.
2. Beware of Charlatans
Why would anyone pretend to be a direct commercial lender? To steal your application fees, of course! There are con men lurking everywhere, and the slick business real estate lenders who greet you with a contract in one hand and a pen in the other are to be avoided.
3. Be Prepared For a Long Wait
Commercial lenders, like home contractors, always exaggerate how quickly the work will get done. In fact, you can expect a three-month processing period, no matter what the lender promises.
4. Toxic Reports
You’ll have to provide a toxic report to the potential lender if you default on your payments and the lender forecloses on your land. After all, the lender is responsible for any cleanup costs if the property is contaminated – unless the lender first gets a Level 1 toxic report to keep on file.
5. Lenders Must Order The Appraisal
Never let a mortgage broker talk you into letting him order the appraisal. Only the lender can do that, or by law, the bank won’t be able to accept it.
6. Wait For The Term Sheet
A term sheet is a written declaration of interest by a direct commercial lender that comes with an estimate of the terms. While it is not binding, it is a very desirable document to have. Don’t agree to pay for an appraisal until you see a term sheet that has terms that are acceptable to you.
7. Location, Location, Location
Location is equally important when it comes to choosing a lender for business real estate. As a rule of thumb, local lenders have better deals than out-of-town lenders.
8. Use Your Deposit Relationship
If your company generates a high cash flow, you can use the promise of a deposit relationship to get a better deal. Promise to transfer all of your accounts to the bank that handles your business real estate. Smaller banks will especially appreciate the additional cash flowing into their coffers.