One of the most crucial and decisive steps in a commercial real estate deal is securing the financing. And whether it’s your first time or your fiftieth time, the process of seeking out this kind of funding can feel incredibly daunting because, essentially, the fate of your deal relies on a third party’s discretion.
Today on the blog, we share some best practices to observe when it comes to real estate financing, including some preemptive things that you as the borrowing can do to impress your prospective lenders and boost your odds of securing the financing you need.
Commercial real estate financing: key takeaways
- Do get your finances in order and figure out your borrowing needs. Your borrowing needs should be based on your down payment amount, current financial commitments, and cash flow projections.
- Do research your lending options. Ideally, you want a fixed-rate mortgage or the option to convert to a fixed-rate mortgage down the line to protect against interest rates fluctuations.
- Do consider getting a pre-approved loan. With a pre-approved, you won’t waste time and energy shopping around for properties that are simply out of your budget.
- Do be prepared for standard lender’s conditions and to submit certain documentation, including a credit report, up-to-date financial statements, a business plan with financial projections, information on your investment and property management teams, details about the property, and, in some cases, an environmental assessment and a building inspection.
- Do consult with a mortgage broker who is well-versed in commercial financing. A broker with commercial experience will know the ins and outs of structuring a commercial real estate loan and will have tried-and-true knowledge of the best mortgage products for real estate investment or asset acquisition needs.
- Do allow plenty of time to secure financing. It’s not uncommon to take six weeks (or more, should due diligence issues arise), to get a final commitment from a lender.
- Don’t expect financing based on projected income. Commercial real estate financing is based on the actual and current net income of the property, so your lender will need to know how much revenue the property is currently producing. Future rent projections are not typically factored in.
- Don’t compare residential real estate financing to commercial real estate financing. Not only are there more costs to consider with a commercial real estate deal, but the costs also tend to be much higher than they would be if you were purchasing a property for residential purposes.
- Don’t forgo formalized lending protocols if borrowing from family, friends, or colleagues. It’s important to stick to formalized lending protocols regardless of your personal relationship with the lender. Your loan agreement should be legally binding and stipulate the loan type, repayment plan, interest rate, and default protocols.
Get your finances in order and create a plan to allocate your cash flow
Before approaching third parties about financing, your first step should be to make sure your financials are in order. The financial information you present to a potential lender will more or less decide whether it’s in that third party’s best fiscal interests to lend to you. In other words, you want to show a prospective lender that your company is profitable and has growth potential—and moreover, that you have concrete, actualized numbers to back those claims up.
Beyond preparing your financials, you’ll also need to map out your borrowing needs. This should be based on your down payment amount, current financial commitments, and cash flow projections. And make sure you’re being realistic about financial forecasts. Unforeseen costs can quickly add up and eat up profit in the year following an acquisition. It’s a good idea to consult with an accountant regarding any financial particulars.
Research your lending options and consider a pre-approved loan
There are a variety of financing options that are available for real estate investors, with a mortgage loan being the main type of financing available to assist with a commercial real estate purchase. With this type of loan, you’ll want to consider the interest rate. If you’re offered an adjustable loan, a variable loan, or an interest-only loan, keep in mind that you will be negatively impacted should interest rates rise. Ideally, you want a fixed-rate mortgage or the option to convert to a fixed-rate mortgage to protect against interest rates fluctuations.
Some more variables to consider are the bank’s terms, including the loan-to-value ratio, the amortization period, and the bank’s flexibility for loan repayment. A pre-approved loan is also an avenue worth exploring. By going the pre-approved route, you won’t waste time and energy shopping around for properties that are simply out of your budget.
You can find out some more financing options to consider as a real estate investor through the Business Development Bank of Canada.
Be prepared for standard lender’s conditions
There are certain documents and conditions that most, if not all, lenders will require before they will even consider you for financing. For instance, investors are typically expected to submit a credit report, so that the lender can evaluate how the borrower has previously handled any credit accounts. You should also be prepared to provide up-to-date financial statements, a business plan with financial projections, information on your investment and property management team, and details about the property, including the type of building, its age and current condition, and its resale potential.
Additionally, some financial institutions require an environmental assessment and/or building inspection to reveal any major work the property will need to be brought up to spec.
Consult with a mortgage broker who is well-versed in commercial financing
As markets for mortgages have become increasingly competitive, the use of a mortgage broker to facilitate loans between the investor and lender has become more popular. If you are planning on using a mortgage broker, it’s important to use someone who has prior experience with commercial real estate dealings. Ideally, the broker will be doing commercial financing on a full-time basis. A broker with such experience will know the ins and outs of structuring a commercial real estate loan and will have tried-and-true knowledge of the best mortgage products out there for real estate investment or asset acquisition needs.
Allot plenty of time to secure financing
Real estate financing takes time. Not only does it take time to find a lender that’s a good fit (and then, to open a line of communication with that lender), but it takes time for a lender to process the conditional information that we’ve mentioned above. As such, it’s not uncommon to take six weeks (or more, should due diligence issues arise), to get a final commitment from a lender. Bear this in mind if you’re dealing with an investment that’s time sensitive.
Expect financing based on projected income rather than actual income
Unless you’re applying for a pre-approved mortgage, you’ll need to provide the lender with the financial information of the income property at hand, in addition to your own financials as an investor or investment company. And while you most definitely should prepare financial projections for the property (based on variables like what you plan on charging for rent and if there will be secondary revenue sources, etc.), commercial real estate financing is based on the actual current net income of the property, not the projected income. In other words, your lender will need to know how much revenue the property is currently producing.
Compare residential real estate financing to commercial real estate financing
Residential real estate and commercial real estate are two very different worlds. When it comes to financing, not only are there more costs to consider with a commercial real estate deal, but the costs also tend to be much higher than they would be if you were buying a property for residential purposes. For instance, in addition to lender and broker fees, a commercial deal might involve costs associated with a commercial appraisal, an environmental report, and legal fees, which can cost thousands and aren’t really necessary when purchasing for a residential purpose. Additionally, costs will be incurred if the commercial property needs to be brought up to spec in any way. All of these added expenses will affect your borrowing needs.
Forgo formalized lending protocols if borrowing from family, friends, or colleagues
Not all lenders will be a bank or an official lending body. In some cases, your lender might be someone you know on a more personal level, such as a family member, friend, or colleague. While there are definitely benefits to going this route—for instance, flexible repayment terms and a lower rate of interest—borrowing from someone close to you can quickly go south. As such, it’s important to stick to formalized lending protocols regardless of your personal relationship with the lender. Your loan agreement should stipulate the loan type, repayment plan, interest rate, and default protocols. Always consult with a lawyer or accountant to ensure that the loan has been structured in a way that’s fair and makes sense for all parties involved.
Invest with Crescendo Equity
The great thing about real estate investing is that anyone can get their foot in the door. That said, it helps to be backed by an experienced team of investors. So, get in touch to find out how you can get in on the action and invest through Crescendo Equity. Crescendo Equity is made up of a team of dedicated senior real estate investors committed to identifying high potential assets, repositioning them for maximum cash flow, and offering exceptional investment returns to partnered investors. Find out more about how Crescendo Equity makes real estate investing simple by visiting our website.