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Finding deals is easy when building a commercial real estate portfolio (CRE). The tricky part is financing.
CRE is one of the most profitable portfolios and offers leverage over housing investments, although interest rates can be high. Commercial real estate loans are a factor.
To understand how to successfully invest in this area, you need to know how loans work and which options will be most beneficial to you. There are many loans available to commercial real estate investors, but each has its own rules. Which one suits your needs depends on your situation.
For example, some investors may use multiple types of debt to support the growth of their CRE portfolio.
DSCR credit
DSCR stands for Debt Coverage Ratio. As the name suggests, DSCR debt measures free cash flow relative to a business's current liabilities. These loans are good for assessing the financial health of a business or investor, helping to determine whether a commercial property will generate enough income to make monthly loan payments.
When calculating DSCR, financial companies divide net operating income by total debt service. Net operating income is calculated as profit less cost of equity. Total debt service includes principal and interest on all outstanding loans.
As a general rule, a DSCR must be above 1.25 to qualify for financing. Anything below 1.00 indicates financial difficulty for the investor or business. Net operating income of $100,000 and total debt service of $60,000 produces a DSCR of 1.67 points. However, if the same company has $95,000 in debt, the score is 1.05.
Hard money loans
Hard cash loans are a safe haven for investors with a less than stellar credit history.
These short term loans are a quick and easy way to get financing for your commercial investment property. The downside is that the interest rate is high and the repayment period is short. The investment is also collateral for the loan, so this combination makes it a risky option.
Hard cash loans are usually available from non-bank sources. Therefore, you will get them from individual investors, financial institutions or investment groups. Given the loan terms, this is a variant of Flipper. If you want to get your property back quickly, a cash loan can be a good idea.
This doesn't always work out well for those looking to hold commercial leases. This can be a quick fix if you know you have funding from another source, but waiting will mean losing the deal. A hard cash loan can be a temporary arrangement until funds are available because it is easy to get.
Hard cash loans are a way to improve the credit history of an investor looking to grow their CRE portfolio. However, this strategy can either work well or fail. Investors need to know the value of the commercial property they want to buy before taking out a cash loan.
The amount requested must cover any repairs or reconstruction. Otherwise, you could end up with a property that you can't afford to renovate and need to sell it cheaply to pay off your short-term debt.
Permanent loan
A permanent loan is a long-term mortgage that is paid after the property is completed and ready for occupancy. The payback period is usually between 15 and 30 years. Average depreciation period is 25 years. Funding can come from banks, credit unions, and even life insurance companies.
Consolidation loans usually replace construction loans taken out for new projects. A permanent loan usually has a lower interest rate. Thus, it allows you to pay off a construction loan and refinance a new property. For this reason, a permanent loan is usually a first home loan.
However, it is possible to get a permanent loan for an existing property. The age of the property will help determine the depreciation period. Properties older than 30 years may have a shorter payback period.
Construction loans
Some investors want to enrich their portfolio by building new commercial properties.
That's where a commercial construction loan comes in handy. It covers real estate development costs including land, supplies and labor. The payment period is based on the construction schedule provided during the application process.
A construction loan can allow you to maintain a manageable balance while the building is under construction. Payments during this period are often interest only, so you typically won't pay until construction is complete. At this point, the investor sells a new property or refinances a business loan.
The disadvantage of construction loans is that they usually do not provide 100% financing. Instead, lenders take 70 to 90 percent of the cost, with investors covering the difference.
In addition to interest, you can expect to pay a guarantee and processing fee. You can include these fees in the credit or refund them sometime after construction is complete. Permanent loans can also cover them.
Who offers construction loans? A popular source is the Small Business Association (SBA). These SBA loans will be provided through a commercial lender such as a bank or credit union. The SBA provides loan guarantees.
You can get a loan directly from a bank or credit union. However, they will consider an investor carefully before paying. They expect you to have an excellent credit history and not be new to commercial real estate investing.
Bridging loans
A bridge loan is a short-term loan you can get to quickly buy a property, close a deal or improve what you already have.
The key word here is "bridge". By design, these loans have very short repayment periods, usually between 12 and 36 months.
Investors should only use them to profit from trading with long-term funding expectations. The finance officer will likely ask for collateral for the loan, which is usually the property you are buying or renovating.
Finding the right business loan is critical to your investment strategy. Find a lender that specializes in the financing you need to get the best interest rate and best chance of approval.
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