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How does Commercial Real Estate Lending Work? – A Quick Guide

Commercial real estate lending involves the acquisition, construction, and development financing of income-producing real estate. It includes commercial spaces for lease to third parties and non-residential real estate occupied by its owners or a related party.

This mechanism plays a crucial role in the economy in various ways. For instance, it provides sufficient capital for businesses to acquire or develop properties. In turn, real estate lending stimulates economic growth and job creation.

In addition, commercial lending contributes to real estate stability, property development, and investments. The availability of financing helps maintain a delicate balance between supply and demand in various property sectors.

But what are the commercial real estate lending guidelines? And what requirements do they entail? This post offers a quick guide on how the process works and how businesses can benefit from it.

Key Players in the Real Estate Lending Market

Various entities contribute to the real estate lending industry. It includes commercial banks, insurance companies, mortgage brokers, etc.

Commercial Banks

This institution is made up of traditional lenders that offer loans for various purposes, such as real estate. They have specific divisions or departments specializing in the commercial real estate lending platform and provide multiple loan options to businesses.

Insurance Firms

Meanwhile, insurance companies generally invest in real estate lending. They leverage their financial expertise and resources to provide borrowers with competitive loan options and terms.

Mortgage Brokers

When businesses decide to loan a piece of real estate, mortgage brokers act as intermediaries between them and the lenders. They assist companies in navigating the lending process, gathering relevant documentation, and connecting them with ideal lenders.

Non-Bank Lenders

In addition, non-bank lenders, including alternative financing sources and private lending institutions, have emerged as players in commercial real estate lending trends. They offer innovative financing solutions, more lenient terms, and expertise in specific borrower profiles and property sectors.

For instance, some alternative financing entities focus on providing banking solutions to cannabis businesses. They ensure they comply with financial regulations whenever they take out a loan, file taxes, or wire payments domestically.

The Real Estate Lending Process

Real estate lending comprises multiple steps to finance commercial property purchases, development, or construction. It usually begins with loan origination, where the relationship team prospects and considers potential borrowing clients.

Evaluation of Assets

When a commercial real estate lender shortlists a client, they analyze the client’s business health, specific borrowing needs, and possible loan structure or terms. Once the lender has secured the client’s commitment to proceed with a formal credit application, the analysis and underwriting stages commence.

This process includes evaluating the property’s market potential and value, assessing the borrower’s financial statements and creditworthiness, and analyzing the risk associated with the loan. At this stage, the bank’s credit committee or adjudication team must provide final approval of the proposed credit structure.

Contract Drawing

Once approved, both parties to the commercial lending real estate contract will finalize the documentation and loan terms. They execute the loan agreement, and the lender’s counsel correctly registers any liens against the business and its assets. This step officially leads to the loan’s closing and funding.

Collection of Loan Proceeds

When both parties have completed all these steps, the loan is advanced, and the borrower gains access to the loan proceeds. Collaboration between the lender, borrower, and other relevant parties, including attorneys and appraisers, is essential throughout this procedure. It ensures a successful and smooth real estate lending experience.

Types of Commercial Real Estate Loans

Several types of commercial lending for real estate are available to businesses, tailored to meet various financing needs. Examples include owner-occupied and income-producing commercial mortgages, construction loans, and bridge loans.

Owner-occupied Mortgages

In owner-occupied commercial mortgages, the operating company with shared control or ownership of the physical property occupies the property. In this case, the operating company’s cash flow services the mortgage. Thus, the business’ overall indicators and financial health underwrite the credit.

This loan type’s rates are typically amortized between 20 and 25 years. In addition, building and operating company expenses influence the debt service coverage ratio calculation to mitigate double-count occupancy costs.

The commercial real estate lender must know how to navigate rent rolls and lease terms. Borrowers are investors in income-producing commercial mortgages. They own property that a third-party entity or business occupies. In this loan, rental payments serve as loan obligations.

Commercial Mortgages

Credit for this commercial mortgage is underwritten depending on the lease maturity profile and tenant quality. The loan is usually amortized between 15 and 25 years, depending on the property class.

A versatile property, such as an office or warehouse, requires a longer amortization period. Meanwhile, a specialized property like a golf course or self-storage is more risky and tends to have a shorter amortization.

Construction Loans

On the other hand, construction finance refers to a specialized type of real estate lending. Commercial real estate lending companies extend support for the building and rebuilding of establishments through loans in advance of realizing potential cash flow.

This loan is riskier than an amortizing commercial mortgage, characterized by predictable monthly payments. In this case, credit is advanced in stages or progress draws, depending on project milestones.

These loans are generally “interest-only,” with no cash interest payments throughout the contract. Upon project completion, the borrower repays the principal amount, including applicable loan interest.

Bridge Loans

Lastly, bridge loans are usually a higher-risk type of real estate loan. It bridges the gap between more traditional types of credit. Commercial real estate lending regulations are stricter for these loans.

For example, a developer completes a project for a cannabis dispensary, and the construction loan is due. However, the cannabis business has yet to take out a loan, so the commercial mortgage lender can’t advance funds.

At this point, the developer would need a bridge loan to finance the construction loan. At the same time, they wait for the cannabis business to occupy the space. It also ensures the commercial mortgage can advance and take effect.

This credit structure is “interest only” and tends to require higher commercial real estate lending rates. Thus, most cash-flow lenders, such as credit unions and commercial banks, don’t practice bridge financing. However, non-bank or private equity lenders take advantage of this opportunity because of their high-risk tolerance for return on funds deployed.

commercial real estate lending

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Fortunately, Safe Harbor Financial possesses industry expertise to ensure your business adheres to these dynamic financial regulations. They have been pioneering innovative solutions, like commercial real estate lending, for companies in the cannabis industry.

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