Commercial Real Estate Loans
Commercial real estate loans are mostly made these days by commercial banks. Of course, the really big commercial real estate loans - the $5 million to $200 million loans secured by huge office towers and shopping malls - are still made by life insurance companies and conduits; but in terms of the number of commercial real estate loans, the banks make more of them than any other type of lender.
Here is another type of commercial lender that you might never have thought about - credit unions. They are flush with cash right now, and they are hungy to make a few commercial real estate loans. The commercial mortgage rates offered by credit unions are usually about 0.25% to 0.375% higher than banks, but credit unions are not nearly so fussy. Wall Street is now back in the market to make subprime commercial loans. These Wall Street lenders call them "nonprime commercial loans." The last active type of commercial lender is a commercial hard money lender, like my own firm, Blackburne & Sons.
Therefore, if you are just starting your commercial loan search, the first place you should contact is a commercial bank. But which bank should you call? There are thousands of commercial banks in the U.S., and not all of them are actively making commercial real estate loans. There are a number of commercial mortgage portals, including C-Loans.com, CommercialMortgage.com, and CommercialLenders.com that will suggest a list of suitable lenders for free. If you are just surfing the net today, any of these portals will do; but if you actually need a commercial real estate loan right now, your best bet is C-Loans.com. Not only can you get a list of suggested lenders; but you can actually apply to all 750 of these lenders right online in just four minutes.
Most commercial banks and credit unions are not nationwide lenders. In fact, most commercial lenders prefer to lend close to one of their branches. If your commercial loan is less than $5 million, you will definitely want to place it with a local lender. The closer your property is to your proposed commercial lender, the lower the interest rate that are likely to enjoy.
But how do you find the closest local lender if you don't live in the area? You need to plot all of the local banks and credit unions on a map and call the ones located closest to the property you are trying to finance. This is actually much easier than it sounds. Simply go to maps.yahoo.com and type in the address of the commercial property that you are trying to finance. You will see a field entitled, "Find a Business." In this field, simply type in "Banks", and instantly all of the nearby banks will be plotted on the map.
Before you go looking for a commercial real estate loan, you need to understand some basic terminology. For example, what's the difference between a permanent loan and a takeout loan? What's the difference between a bridge loan and a swing loan? What's the difference between a takeout loan and a takeout commitment? Relax. I promise to quickly teach you just what you need to know, using everyday English and lost of examples. Onward.
Twelve Types of Commercial Real Estate Loans
- Permanent Loan - A permanent loan is a garden variety commercial real estate loan used to buy an existing apartment building or to refinance an office building. More precisely a permanent loan is first mortgage loan on an income-producing property that has a term of at least five years and at least some amortization (typically over 25 years).
- Takeout Loan - A takeout loan is just a garden variety permanent loan that is used to pay off a construction loan on a new-completely commercial project. For example, your successful machine shop has been renting industrtial space for 20 years, and you are "tired of buying feed for a dead horse". So you buy some land in an industrial park, and then you go the bank for a 12 month construction loan. After ten months, you have completed the building of your dreams. The banker reminds you that his balloon payment is due in two months, so you go another bank and get a new permanent loan to pay off your construction loan. Because your new permanent loan is paying off a construction loan, this new permanent loan is called a takeout loan.
- Construction Loan - A commercial construction loan is a 12-month or 18-month loan used to build a new commercial building. The special thing about a commercial construction loan is that the funds are released to the owner-builder or the general contractor only as work progresses. The bank is not going to just hand you $2 million and then watch you drive off to Vegas with Lola La Boom-Boom. Monthly interest payments on a construction loan are paid out of an interest reserve built right into the loan, and interest is only paid on the amount of money disbursed to date by the construction lender. For example, suppose you obtain a $2 million construction loan to build that dream industrial building. At the end of month three the bank has only disbursed $500,000. You, the borrower, would only have to pay interest on $500,000 that month, not on the entire $2 million.
4. Forward Takeout Commitment - A forward takeout commitment is just a letter, issued by a permanent lender, that promises to deliver a takeout loan at some future date (usually 18-months forward), assuming that the property has been constructed according to plans and specifications and which has reached the target occupancy rate (90%?) at the projected rental rate. These letters are very expensive, often one or two points ($40,000 in our $2 million example!), not counting an additional one point if the loan actually funds. Fortunately most commercial construction lenders today no longer require a forward takeout commitment, thereby agreeing to make their construction loans uncovered or open-ended (same thing).
5. Standby Takeout Commitment - A standby takeout commitment is the same as a forward takeout commitment, except the loan terms are ghastly. A standy takeout lender might charge two to three points, just for the commitment letter, plus another two points if their standby loan every funds. The interest rate on the standby loan might be a whopping Prime plus 6%. Standby loans are never expected to fund. The standby commitment is issued only to satisfy some nervous construction lender. History has shown that standby lenders almost always find some legal excuse to weenie out of their commitment to fund, so the practice has fallen out of favor.
6. Bridge Loan - A bridge loan is a short term commercial real estate loan made to give the borrower time enough to lease out the property and/or renovate the property. Bridge loans typically have a term of one or two years, and they are usually written as interest-only loans. Most have a six-month extension for one additional point, if exercised. The interest rate is usually about 3% to 5% higher than the going permanent mortgage rate, so they are not cheap. Fortunately bridge lenders are usually much faster than permanent lenders.
7. Swing Loan - A swing loan is just another way of saying a bridge loan. There is no difference.
8. Second Mortgage. A few hard money commercial lenders still make second mortgages on commercial properties, but the second mortgage business has largely been replaced by mezzanine loans and preferred equity investments. The reason why is because virtually all modern bank first mortgage notes expressly forbid the placement of second mortgages behind them.
9. Mezzanine Loan - A mezzanine loan is a personal property loan against the stock of the corporation that owns the building (more precisely against the membership interests of the LLC that owns the building). If you execute (foreclose) on the stock of the corporation, then you own the corporation that owns building. Why use a mezzanine loan? Why not just use a second mortgage? The answer is that a lender can execute (foreclose) on a mezzanine loan in just six weeks, rather than 18 months for a mortgage.
10. Preferred Equity Investment - A preferred equity investment is not a loan. A preferred equity investment is an investment in the LLC that owns the commercial property. The preferred equity investor gets paid a preferred return before any of the other members of the LLC get paid anything. Therefore if a commercial property throws off $100,000 in net income, after debt service, each year, and the preferred equity investor's preferred return was $80,000 per year, the remaining members of the LLC only get to share $20,000 among themselves. On the other hand, if rents increase and the property starts throwing off $300,000 in income, then the preferred equity investor still only gets his $80,000; and the remaining members get to share among themselves a whopping $220,000.
11. Joint Venture - Joint ventures are usually development projects. Some huge lender (often a Top Ten life insurance company) provides some filthy rich and very experienced developer 100% of the cost of construction, in return for an agreed upon interest rate and, say, 50% of the profits. Here is a useful rule of thumb: Neither you nor I will ever obtain or close a joint venture. Only the gods of the real estate development industry (the folks like the Trumps) will qualify for a joint venture.
12. Venture Equity - Venture equity investors will provide 50% to 90% of the equity required by a commercial construction lender, in return for the lion's share of the profits. Venture equity comes from much smaller entities than life companies, entities like hedge funds, opportunity funds, and REIT's.
Below are some interesting articles about commercial real estate loans and commercial real estate lending that you may find helpful: