From Rates to Payments: Inside CRE Loans

While you may be intimately familiar with the process of obtaining a residential mortgage, commercial real estate loans, or CRE loans, can be quite different in a variety of ways. Before embarking on a search for commercial property, it is advisable to understand the details of commercial loans.

Commercial real estate loans are most often obtained by business entities rather than individuals. This is done for the purpose of keeping business and personal interests separate. The business seeking a loan will submit financial statements and tax returns to potential lenders as a means of demonstrating their creditworthiness. Potential lenders for commercial real estate loans can include banks, credit unions, pension funds, insurance companies and even private investors. The Small Business Administration (SBA) also has a commercial loan program that can be a source of financing.

When evaluating borrowers for CRE loans, a lender will also look at the loan-to-value (LTV) ratio, which is expected to be less than 80%. In some cases it can be as low as 50-60%, depending on other sources of financing that the borrower plans to assemble.

A lender will also evaluate the expected debt service coverage ratio (DSCR) for a property. Because commercial properties typically generate rental income, it is expected that borrowers will apply such income to the loan payments. The DSCR is calculated by dividing the annual net operating income of the property (gross rental income less operating expenses) by the total payments on the mortgage debt over the course of the year. The DSCR should be more than 1; a DSCR of less than 1 indicates a negative cash flow, which would make the property a poor investment. Lenders may require a minimum DSCR of 1.15 to 1.35.

CRE loans typically have shorter repayment periods, ranging from five to 20 years. The longer the repayment period, the higher the interest rate. The amortization period may be longer than the repayment period, and the borrower may be required to make a balloon payment for the balance due on the loan at the end of the repayment period. Lenders also may stipulate that borrowers cannot make advance payments or pay off commercial real estate loans early, as loans are often approved based on an anticipated yield over the life of the loan. Early repayment can alter that anticipated yield.

This is a brief overview of the ways in which CRE loans work, including interest rates, repayment periods and financial ratios for qualification. To gain a complete understanding of the intricacies of commercial real estate loans, further research is highly recommended.


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