In lending, there are different ways to garner a real estate loan. Typically, people think only of banks, but loans are available from multiple sources, including pension funds, life insurance companies, credit unions, Wall Street and the government.
“There are lots of ways to get loans,” says Terry Coyne, SIOR, CCIM, an executive vice president with Grubb & Ellis.
Depending on the size and type of the investment you want to make, there are many different loan vehicles to help fund your commercial real estate purchase, he says.
Smart Business spoke with Coyne about what options exist to fund a commercial real estate purchase, from both an investor’s and an owner/occupier’s perspective.
What is important to know when it comes to financing commercial property?
In the commercial property market, if you’re an investor, you have a different goal than if you are an owner/occupier. An owner/occupier is much more interested in paying off the building and getting rid of debt, while an investor is more interested in cash flow.
Owner/occupiers are at the top of the pyramid as far as desirability to a lender because lenders like owner-occupied buildings. It gives them the security that the loan was used for the purpose for which it was intended and that there isn’t an absentee landlord. In addition to conventional bank loans, owner/occupiers can also harness life insurance, pension funds, commercial mortgage-backed securities, Small Business Administration loans and possibly opportunities from the state government, depending on the intended use of the commercial property. For instance, if you’re a manufacturer, you might qualify for the Ohio Enterprise Bond Fund, which is tax free.
How can owner/occupiers determine the right funding vehicle for their situation?
Typically, you will have a relationship with a bank, and that will help you get financing. There are also mortgage brokers who are paid to handle your entire transaction. There are many different companies in Northeast Ohio you can go to that will handle all of the applications and work with banks and other resources to come up with a solution.
But it really depends on your goal. For owner/occupiers, the bank you use for your daily needs is typically going to give you the best loan. That lender is often hard to beat because it knows you and wants to expand the relationship. However, you will probably end up with a recourse loan, which means you’re signing personally and the bank can come after you for your personal assets in the event of nonpayment. While bank loans will have the lowest interest rate and the highest loan-to-value, they’ll also typically have the highest risk because you’re signing personally.
How can investors assist?
Investors that are buying a building that is fully occupied will have many of the same options as an owner/occupier but will likely be looking for a lower interest rate. Because you’re an investor, you’re used to putting equity in a deal, so you’re likely willing to live with a lower loan-to-value. Banks will give you more money — typically a higher loan-to-value — than life insurance companies and pension funds because you’re typically not signing personally, so they need to protect themselves. They’re making a loan purely against the real estate and not against your ability to pay.
What are the pros and cons of each lending product?
Typically, bank loans have a lower interest rate with a higher loan-to-value than other products, but you’ll likely have to sign recourse. Also, the prepayment penalty, or the penalty for paying off the balance of the loan early, can be an issue.
Life insurance and pension fund money are going to have competitive interest rates that are comparable to those offered by banks but have a lower loan-to-value. Although less money is being advanced on the loan, you’re not obligated to sign a personal guarantee.
Another aspect is the amortization. If you go to a bank, it wants to amortize the loan as short as possible — 15 to 20 years maximum. A life insurance company will, in some instances, go 30 years, so your payments will be much smaller.
SBA loans are government-backed and made through a bank. They offer a greater loan-to-value than any other product and have very compelling interest rates. Also, you’d likely get a greater advance.
Commercial mortgage backed securities are loans from an entity that sells loans as a bond, which can be publicly owned. These bonds comprise hundreds of loans, of which a person owns a share. This market was huge until the crash, when it was discovered that no one knew what types of loans — or the ratings the loans had — that were inside these bonds. The commercial real estate side, however, wasn’t guilty of concocting crazy loans packages like the residential side was.
This market is back in a big way. It offers cheap money with very good terms on loan-to-value, which could be comparable to what a bank might offer, with similar interest rates and more amortization. The downside is that you can’t prepay, because they’ve guaranteed the bond’s investors a return. This means that if you sell your building soon after purchase, you won’t be able to pay off the entirety of the balance immediately without going through a complex process.
Lastly, there are lenders that are not regulated but that have private funds, hedge or otherwise, that will lend money for commercial real estate. They act like other lenders, but you’re usually going to them because you have a unique need that can’t be met by conventional lenders.
A mortgage or commercial real estate broker could help you tap into this type of financing.
Terry Coyne, SIOR, CCIM, is an executive vice president with Grubb & Ellis. Reach him at (216) 453-3001 or [email protected]
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