How Is Commercial Real Estate Financing Different Than Residential

How Is Commercial Real Estate Financing Different Than Residential

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When discussing the differences between commercial and residential real estate financing, the main thing you need to worry about is the differences in the loans you can get.

As commercial real estate generates income for the owner, the commercial loans thus tend to be different from the residential ones.

The Loan is Sized and Underwritten Differently

The main difference comes in the fact that commercial loans are underwritten and sized according to the NOI of the asset, or the asset’s projected net operating income. For those not familiar, the metric measures the profitability of your property before the costs of taxes and financing are added, and it doesn’t include capital expenditures.

It’s expected that a commercial loan borrower will have:

  •       A high enough net worth when compared to the loan request

  •       Great credit score

  • · Some partner or individual experience in the class and market of the asset

It’s also significant to mention that commercial loans are given to entities, not individuals. You need to have a corporation, limited partnership, or some other business entity.

Shorter Terms and Periods

Unlike residential loans, commercial loans typically have shorter terms which range typically from five to 20 years, with balloon payments at the end of the term.

Additionally, the amortization period is usually shorter in commercial loans than in residential ones, and are typically longer than the actual term length of the loan. That entails smaller monthly payments and higher total interest costs, the exact opposite of what happens with residential mortgages. In the end, the fact that the amortization period is longer than the terms of the loan also means that the borrower has to make payments for the entire length of the terms and then make a final ‘balloon’ payment that comprises of what’s remaining from the loan.

All of this is subject to negotiations, as long as you have an excellent credit strength.

Additional Fees

As commercial lending has higher interest rates, they also have additional fees, which add more to the overall cost of the loan. These fees might include:

  •    Loan origination fees

  •    Appraisal fees

  •    Loan application fees

  •    Legal fees

  •    Survey Fees

Naturally, how many additional expenses you have usually depend on the exact loan you’re getting.

Prepayment Restrictions

It’s not always the case, but commercial loans can have restrictions on prepayments, which are usually made to ensure that the lender has earnings until the loan’s maturity date.

When these restrictions exist, that means that you have to pay several penalties if you pay off the loan before the maturity date.

Differences in the Loan-to-Value Ratios

The loan-to-value ratio, or LTV for short, measures the exact value of a loan in comparison to property value. The lower the LTV, the more favorable financing rates the borrower can realize.

The difference between commercial and residential real estate loans is that the LTV tends to be higher with residential mortgages, up to 100% even. As for commercial loans, the maximum LTVs go in the 65% to 80% range.

For more information on how commercial real estate loans differ and function, you may reach us at info@cbi-commercial.com

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