Wednesday, August 28, 2013

How To Finance Commercial Real Estate

I was recently doing some research for a real estate investor's club meeting on how to fund commercial real estate and had trouble finding this information online. So... Here it is as of August 2013.

Let's say you want to buy an apartment complex larger than 4 units (that was one of the properties we practiced analyzing as a group). Those, whether it's 5 or 500 are considered commercial real estate. That means you need to get a commercial loan. When you go to a business-based bank, like Citizens Bank, here's what they'll tell you. Again... this is all subject to change, but these should work as general lending rules.

  • First, the downpayment minimum is 30%! That could come from the seller (or anyone really) as long as they're willing to take 2nd position to the main loan.
  • Second you can only get a loan for 20-25 years.
  • That loan will probably have an variable rate, which can adjust every 3-5 years.
  • Your personal credit score, though looked at, doesn't matter as much. If you're buying with a bunch of investors as an LLC then the majority owners would have to guarantee the loan payment.
  • Instead, they'll look critically at the income and expenses of the property. The income must be at least 1.24 (call it one and a quarter) of all expenses, including all debt repayment.
  • Closing costs will be the fairly standard loan fee: 1% of mortgage. Plus the fairly standard 4% of the purchase price for title insurance. Plus recording fees of course, but those are minimal.
  • Often times, since these are larger properties with considerably more risk, the lender will want to do an environment impact report to make sure nothing comes up.
  • That's it. Gather your funds and paperwork and you can buy a commercial property.

This means you need a TON of capital to buy a property though. The specific one I was analyzing met all the criteria if I had enough money for a downpayment and closing costs. Well... except that I don't have $200,000 to invest... So I guess I don't meet all the criteria! I did officially find out that not having enough money is the #1 reason why people don't qualify. No kidding!

Now, if the seller was willing to take back a 2nd for the down payment, and even though it would still have positive cash-flow, the rent-to-expense ratio would become less than 1.24 in this case and I wouldn't be able to finance the rest of the purchase. Bummer. But... if the right property came along that still met the criteria, it would be totally cool. Good luck finding that deal on the MLS.

It could also work, in theory, with a group of investors adding up to the $200,000 minimum down. Of course, I don't exactly know how to find people with lots of cash waiting to be invested... Plus, I'd have to have a very clear exist strategy, somehow prove my credibility, and put in a ton of work... but it could be worth it. I know some people do this full-time with larger properties where the scale makes it worth the effort. They find deals, find investors, property managers and get part of the equity for pulling it all together. I actually would like to learn more about this style of investing.

Anyways, that's what it takes to finance a commercial property. It's way out of my league today, but still fun to think about.


  1. Mocko7:46 AM

    Hey James. Also, be aware that the banks look at expenses differently than you or I would. For instance, even if you manage the property yourself, the bank will add in a management expense of 5% to determine net income. Logic is just in case you are no longer able to manage yourself, they want to see the property stand on its own. They also have other "minimum" expense percentages on some items as well as a "capital reserve" expense. All of these can catch an new investor by surprise if they analyze a marginal property.

  2. I didn't know that. Thanks for sharing!

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