Should You Get a Hard Money Loan for CRE?

Once you’ve found the right property, getting the financing you need to make the deal happen can be a significant hurdle for someone with hopes of investing in commercial real estate. A commercial real estate loan could be an option. But it’s important to understand:

• How the CRE loan process works
• Ways to get a CRE loan
• Using the loan once you’re approved
• What kinds of CRE loans are available
• Why you should consider a hard money loan for a commercial real estate transaction
• How to choose the right lending partner

Reid Lending Partners offer investors the opportunity to indulge in the dream of property investments. Learn more.

What is a Commercial Real Estate (CRE) Loan?

A CRE loan provides financing to purchase or renovate an income-producing, non-residential property. CRE properties include retail stores, hotels and resorts, and office complexes.

In a CRE loan, the asset itself becomes the security, just like a house is the security for a residential mortgage. There are a lot of similarities between residential and CRE loans, but a CRE loan opens up more options and benefits for the business owner or would-be CRE investor.

Benefits of Commercial Real Estate Loans

Commercial real estate investors and business owners can appreciate the benefits of commercial real estate loans. Some of the greatest advantages of CRE loans include:

A flexible repayment period

A residential real estate loan typically lasts for 30 years at a fixed interest rate. Commercial real estate loans, on the other hand, have a variety of repayment structures. For instance, the repayment period is usually much shorter. The typical CRE repayment period is anywhere between five and 20 years — but, unlike a residential property loan, a shorter repayment period doesn’t always mean monthly payments are higher.

Sometimes, a CRE repayment schedule can include a balloon payment. The borrower makes monthly payments for five to 10 years. These payments can be particularly low, because amortization works as if the loan repayment period were actually 30 years, just like a residential loan. The borrower and the lender will have agreed on a five-year or 10-year repayment period, throughout which the borrower makes those low, monthly payments. At the end of the repayment period, the borrower is responsible for a lump sum payment for the amount remaining on the loan, known as the balloon payment.

Some lenders also allow longer repayment periods but a longer repayment often translates into a high interest rate. Decide which repayment period is the best for your business and financial situation.

An entity receives the loan

Residential property buyers and investors apply for a real estate loan individually. In other words, the loan is in their own name and becomes their personal responsibility. CRE loans, on the other hand, are applied for and received by an entity, company, or other partnership that’s investing in the asset. However, this doesn’t negate any personal responsibility — the people responsible for the controlling entity can still be held responsible individually for loan repayment.

A CRE loan that relies solely on the commercial property as loan collateral is called a non-recourse loan. Lenders don’t pursue the entity’s individuals for any unpaid portion of a non-recourse loan. This isn’t the typical CRE loan process, however.

Usually, a commercial real estate loan is remedied by recourse. A recourse loan allows a lender to pursue any individuals belonging to the business entity. This protects lenders with greater security when offering a CRE loan to a business that has no credit rating.

CRE Loans: Common Penalties and Fees

A commercial real estate loan can have specifications that impose additional fees or penalties on a borrower. When you research lenders, read the fine print — find out how much the loan will actually cost.

For instance, does the lender charge a prepayment penalty? This can apply to commercial projects when it’s sold sooner than expected. Hopefully, the original investor sells for a greater price than the original purchase. Lenders make money not just from the monthly loan payments, but on the interest rate attached to the loan. When you flip the property and pay off the remainder of your original loan, the lender might charge a percentage of the amount remaining on the loan as a prepayment penalty.

Sometimes, this prepayment penalty is written specifically into the loan’s contract. For instance, if the borrower pays off the loan early, a penalty charge equal to five years of interest would apply. Some lenders don’t allow early repayment, so don’t sign any loan agreement until you understand its terms.

Other fees include origination fees or annual fees — sometimes both of these can apply in CRE lending.  

Where to Find Commercial Real Estate Loans

The traditional option of financing a CRE purchase — going to your bank’s physical branch location — isn’t the only option for today’s borrowers. Every loan has its own set of barriers, so careful research can help you find the CRE loan that works for your unique situation.

Physical bank branch

If you’re looking for a long-term loan, a traditional bank could be a good fit. Traditional banks tend to offer borrowers longer payback periods and low interest rates. Well-known banks often provide a certain level of “comfort” from a recognition standpoint, but this type of traditional lender is able to offer these relaxed terms because they don’t offer loans to just anyone. They’re quite selective. Plus, a traditional bank typically has the toughest loan requirements and it can take much longer to finalize a loan.

Commercial loan providers

A commercial lender is great for borrowers who want a fast underwriting process or whose financial strength isn’t perfect. These lenders offer products to a much broader audience, have an easy application process, and the time to funding isn’t as long as that of a traditional lender.

This convenience comes with a price, though. You’ll likely have a much higher rate than a traditional bank loan and a much shorter repayment period. For a five-year loan, you’d be looking at a sizeable balloon payment at the end of the fifth year.

Hard Money lending

Hard money lenders have even faster processing times and far fewer hoops to jump through than conventional lenders. A hard money lender is a private lender that engages in short-term lending based on a property’s value. A hard money loan doesn’t rely on the borrower’s creditworthiness, but rather on the property’s merits. It’s this specific caveat that often means you’ll pay a much higher down payment than with other loan types.

SBA Loans

A Small Business Administration (SBA) loan is an appealing option for SMB owners. The SBA is an agency of the federal government focusing on the advancement of United States small businesses. One of the most important aspects of their work is business loans guaranteed by the agency.

The SBA doesn’t provide the funding, but rather works with outside lenders to obtain loan approval, guaranteeing compensation for part of the loan should the borrower default.

An agency-backed loan can increase a borrower’s appeal among lenders. There’s significantly much less risk involved on a lender’s behalf when working with the SBA. The guarantee offered also gives the borrower additional power: longer time to repay, full amortization, and low, competitive interest rates.

While an SBA loan is obviously desirable, it can be difficult to qualify for one. For instance, an SBA loan requires borrowers to occupy the property the loan is for, by at least 51%. If the loan is for new construction, owners must occupy at least 60% of the property.

There are seven different SBA loan types with varying requirements. The most popular SBA loans for commercial property are:

• The SBA 7(a) Loan. This is the SBA’s most prized loan offering. Part of the allure is that this loan guarantees as much as 85% for loans under $150,000. This guarantee opens up the world of lending to a lot of borrowers who wouldn’t otherwise qualify. On the other end of the spectrum, well-qualified business owners can obtain a loan up to $5 million with the SBA guaranteeing up to 75%. The 7(a) loan can allow up to 25 years for repayment. The only drawbacks of the 7(a) are slow processing, needing a decent credit score, and requiring enough operating income to prove the loan is likely repayable.
• The SBA 504 Loan. The 504 program offers a popular loan for real estate projects. The max loan amount is $5.5 million. This loan also takes longer to process than traditional loans and requires good credit and strong repayment capability. The greatest draw of 504 loans is low interest rates (even less than 7(a) loans). But these loans can also have a 25-year repayment period and can be amortized in full, avoiding a large balloon payment. Borrowers can use a 504 loan for new construction, existing structure purchases, existing structure renovations, and even city or state infrastructure.

How to Qualify for a CRE Loan

A CRE borrower’s finances will be examined as strictly as a residential loan borrower’s. As a business or investor, it’s likely your finances are more complex and a bank statement won’t be enough to prove your financial standing.

A lender strives to minimize risks by reviewing a business’s credit history, current financial status, and may even review the business owner’s personal credit. Small businesses don’t always succeed and a lender protects its own interests by only partnering with businesses that can prove worthiness.

Part of the application process requires the submission of business records, such as profit and loss statements. The exact documents you need to provide vary among lenders.

Before offering you a commercial real estate loan, lenders review your:

Credit history

A lender can pull your business’s credit history via FICO’s Small Business Score service. For companies that are brand new and have no business credit, a lender can instead determine creditworthiness based on the business owner’s personal credit.

Net operating income

Prior to funding, a lender wants reassurance that, even if your business has stellar credit now, the business will be creditworthy in the future. To deduce this, the lender carefully reviews the finances of the business. The most important item the lender is looking for is the business’s net operating income (NOI).

NOI outlines all annual income sources following the deduction of the business’s annual expenses. This calculation doesn’t take capital expenditures into account. It also doesn’t include taxes or any loan or interest payments the business makes on current debts. The resulting NOI figure when calculated against the ratio of debt to service helps the lender propose the maximum loan they’re willing to offer the borrower.

Debt-to-service coverage

To find the debt/service (also called debt to service coverage) ratio, a lender divides the borrower’s NOI by the business’s annual ability to repay a specific loan amount. Low debt/service ratios can mean less ability to repay a loan but not necessarily disqualify a borrower. The borrower may be approved but with a higher interest rate. Businesses should aim for around a debt/service ratio of around 1.25 or so, but if your business is in a particularly high-risk industry, it’s possible the lender will require a higher ratio.

“A well structured private hard money loan can present a win/win for both parties.” – John Reid

Why is a Private Hard Money Loan the Best Option for Commercial Real Estate?

Above, you learned there are several methods for borrowers to obtain funding for commercial real estate investments. Of these options, hard money loans could actually work out in the best interests of a borrower.

Historically, hard money loans have earned their name — they can be rather difficult to obtain. That said, hard money loans are typically the first option CRE borrowers consider. In fact, hard money is ideal if you need the funds quickly to seal a deal.

Depending on the lender, you might be subjected to greatly varying requirements. In most cases, you might need other assets to offer as collateral. The lender might also ask for documentation proving your income, credit history, and current debt coverage amounts.

But regardless, hard money loans are ideal for CRE investors because:

Approval is fast

Traditional lending for anything and any amount is stringent. Hard money loans, on the other hand, have very few requirements and an easy application process. You can even get conditional approval in some circumstances.

The most crucial item the hard money lender will examine is the value of the commercial real estate. If the property you want to obtain meets the LTV, or Loan-to-Value, requirement, closing will be fast. Most hard money lenders won’t spend too much time viewing income reports, bank statements, or your credit history.

For instance, If you need this funding for a massive project, a CRE hard money loan keeps you on your schedule and mitigates the potential to lose out on a good deal.

Flexibility

Hard money lenders specializing in commercial property loans, like REID Lending Partners, don’t use a traditional underwriting system. Rather, each borrower is reviewed individually. Guidelines for approval are based on the asset’s equity. Hard money lenders apply common sense to credit scores and income documentation. Your rate is based on perceived risk. If the lender perceives no risk, your interest rate and repayment plan will be more favorable.

Convenient deals

Commercial real estate investors often keep their eyes open for the next best deal. Funding projects is limited only by — well, funding. If you can purchase a property outright, you can often get a reasonable price. You can even snag fantastic properties at cash auctions when you’ve got the money in hand.

When you’ve got several projects on the go at once, though, snagging a deal is a little tougher. CRE hard money loans allow you to finance those purchases easily. Some programs even allow LTV up to 75%, which frees up even more cash to put towards the investments you’re eyeing.

Great for flipping

Fix-and-flips are some of the most challenging transactions for CRE investors. First, you have the option: fix and flip, or fix and rent out? Both are viable options for commercial real estate investors. But making the most of your current investments means having a lot of them. Fix and flip hard money loans let you build up a stout portfolio fast thanks to the benefits already listed above, such as fast approval times and flexible repayment plans.

Enviable CRE properties don’t stay on the market long. Traditional lending’s long approval process means missing out on what could be the score of your investment career.

Fix and flip investments tend to rise in market value. Then you can sell the property, repay the lender, and reinvest the profits. Hard money loans for fix and flip commercial real estate lets you buy and flip faster.

Private Hard Money Loans: The best option for CRE Investors

A well structured private hard money loan can present a win/win for both parties. You might not meet traditional lending qualifications, but hard money loans could be your ticket to financing. Hard money lending terms are flexible and have fast approvals, meaning you can structure deals as you desire and expand your CRE portfolio quickly.

If you’ve ever lost out on a really great deal because your leverage was tied up in a bank loan officer’s to be read pile, REID Lending Partners might be the partner for you.

REID Can Help with Private Hard Money Loans for Commercial Properties

Hard money lending has a bad reputation. Disreputable lending has taken advantage of borrowers who didn’t comprehend the fine print in their loan documents.

If you need financing, don’t fall prey to a private lender’s collateral-based hype. Your partner in lending should be exactly that — your partner. Choose a lender that’s not afraid to show proof of their practices.

REID Lending Partners (RLP) provides a quick and easy application process for asset-backed loans. If you need sensible and affordable access to capital for your CRE investments, contact REID today.