How CRE Loans Work
Commercial real estate loans, or CRE loans, are the means used by buyers to finance commercial property. Just as homebuyers are rarely able to buy residential property outright and require a mortgage to purchase a home, commercial buyers use loans to buy properties like office buildings and retail space. While there can be some similarities between residential mortgages and commercial real estate loans, the latter usually work quite differently.
CRE Loans: Who Seeks Them, Who Approves Them
Unlike residential mortgages which are obtained by individuals, commercial real estate loans are usually sought by business entities. Even if there is a single person behind the investment, they will typically establish a business entity such as a partnership, S corporation or Limited Liability Company (LLC) to separate their business interests from their personal finances.
While the same financial institutions that approve residential mortgages can also traffic in commercial real estate loans, there are more options beyond banks and credit unions for financing commercial property. Sources for commercial real estate loans may include private investors, insurance companies and pension funds. The Small Business Administration (SBA) also has a program for commercial real estate financing.
Qualifying for CRE Loans
As with residential mortgages, commercial real estate loan approval depends on the creditworthiness of the borrower, financial history and income tax returns, and various financial ratios that can help assess the likelihood of full repayment of the loan in accordance with the approved terms.
The expected loan-to-value (LTV) ratio for a commercial real estate loan is usually within the range of 65-80%. Contrast that with an LTV of 80% or even more for a residential mortgage. Another ratio used for commercial real estate loans is the debt service coverage ratio (DSCR) which refers to the ratio of income generated by the property to the borrower’s debt. A lender may establish a minimum DSCR that a property must meet in order for the borrower to be approved for a loan.
Commercial Real Estate Loan Terms
Yet another difference between residential and commercial loans is the terms. While a residential mortgage term can be between 15 and 30 years, commercial loan terms are much shorter and may include a balloon payment at the end for the balance of the loan. Likewise, while there are no penalties for paying off a residential mortgage early, there can be penalties or restrictions on paying in advance on CRE loans.
In some ways, commercial real estate loans operate similarly to residential mortgages, but they differ in other aspects including qualifications and terms. It may be helpful to clearly understand all the differences before seeking a CRE loan yourself.