If you are a borrower seeking a commercial real estate loan, what’s the first question you ask?
There are a lot of brokers and commercial lenders competing for your business right now, and what they almost always offer you is lower interest rates. But is this the true “cost” of your loan?
The answer is–it depends. It depends on what your objective is. Are you refinancing a property to pull the maximum cash out to use for property improvements? Are you seeking to minimize your monthly outflow on an under-performing property? Are you planning to sell in 1-2 years and re-invest your profits?
In general there are three sets of costs associated with any commercial real estate loan:
Getting into a commercial real estate loan is not inexpensive. Sophisticated borrowers understand the costs to document and close a loan and factor these expenses into the cost of the property. These costs can include commitment fees, a commercial appraisal and other third-party reports such as surveys, site visits, market analysis, environmental reports and engineering studies. In addition, a commercial borrower should plan for broker fees, loan origination points, underwriting fees, title insurance and other closing expenses. Legal fees alone can run to 1% of the purchase price or value of the commercial property. These factors should all be included in your overall cost of financing, especially since many of these items come out of your pocket prior to closing.
Once you are in the loan, the key factor is the interest rate. Is it fixed or floating? If fixed, for how long? If it adjusts, is there a cap on how much the interest rate can adjust? Is the monthly payment fully amortized or interest only? A three-percent interest rate on a multi-family loan can sound really good, but if your loan payment is interest only and you do not buy down the principal, how much is that loan really costing you? Another factor that affects the monthly payment is length of time the loan is amortized over. A 25 year amortization with a 5-year balloon results in a lower monthly payment than a 15 year amortization.
When exiting the loan, or the property, the most important factor is any pre-payment penalty. Most conventional commercial loans, also called conforming loans, have a 5-4-3-2-1 prepayment penalty. Read this as 5% the first year, 4% the second year, etc. If you are planning to hold the property for 10 years, no problem. But, if you have purchased an under-performing property and are planning to upgrade it and get it fully rented, don’t be afraid of a hard money loan at 12% that comes with no pre-payment penalty. This means you can refinance at any time, often with the same lender.
Overall, the true cost of a commercial loan has more to do with your objectives and overall financial goals than the interest rate you are being charged. If you are clear about your financial objectives, you will find that private commercial lenders can be the most flexible in helping you with the best loan package. They are not going to just quote rates at you. In fact, just the opposite. You will find your borrowing needs carefully reviewed and a proposal offered with room for negotiation to get to the best solution overall.
I am currently working with a client purchasing their first commercial property. They are planning to move their existing business out of leased space into their newly purchased property which is 50% vacant. Because of the high vacancy rate, they could not get a commercial loan from their regular bank. Also, because they didn’t realize that commercial lenders offer lower loan-to-value than residential lenders, they were a little short on cash for closing costs. Our very creative commercial lender, not only offered them a loan, but took a look at their overall portfolio and came up with a way to blanket an extra property to generate the additional cash that will be needed to close on the commercial purchase. The cost and tax savings from moving their business out of leased space, plus the growth potential in their own property more than compensates for the slightly higher monthly payments.