Types of Commercial Real Estate Financing
February 9, 2021
If you’re a real estate developer or investor, you’ll probably need to get some type of commercial real estate loan. Banks and other traditional sources of capital, including insurance companies, credit unions, or pension funds, have traditionally been sources of financing. Since the 2008 market crash, rules and regulations have forced banks to tighten up their commercial lending.
Alternative lenders have stepped in to fill an important role in the commercial real estate industry. For this reason, borrowers might need to raise more equity from investors and partners as well as debt financing. Borrowers can turn to a private lender to fill the void in a loan.
There are several sources to finance real estate projects and each avenue will have their own pros and cons. As a borrower, you’ll want to connect with lenders who offer quick financing and flexible options that suit your business plan.
The common types of financing
Construction financing is a loan which covers the acquisition, development and the construction aspects of a project. Developers use it in purchasing a parcel of land, installing the utility and the street services and then in constructing buildings. The principal amount is advanced and involves progress payments and generally applied to the asset's permanent financing.
Bridge financing is short-term financing with maturity that allows commercial properties to reach stabilization and to pay off the construction loans until permanent financing can be obtained. Private investors frequently provide bridge financing for the acquisition of property and is subordinated to permanent financing, the source of its repayment. Bridge financing can give owners the flexibility they need to reposition and stabilize properties.
Permanent financing options are conventional, long-term commercial real estate financing from banks, life insurance companies, or credit unions. Most commercial permanent loans are amortized over 25 years.
Mezzanine financing can be used as a financing source for corporate expansion projects, acquisitions, recapitalizations, buy-outs, and leveraged buy-outs. It can be structured in many ways, with both debt and equity. This type of capital is usually not secured by assets, and is lent strictly through a company's ability to repay the debt from free cash flow.
Stabilization is when a development project or acquisition achieves a certain level of completion and is ready to qualify for permanent financing.
There are many factors that can lead a business to default on a commercial mortgage. This risk factor, along with the sum of money being so considerable in commercial real estate, lenders generally charge higher interest rates for commercial real estate loans than residential mortgages. Interest rates may vary depending on the current market and risk factors involved.
As a borrower it’s important to find a lender that not only offers the type of loan you want but also has rates you can afford and qualification requirements you can meet. Each option has its own rates, terms, eligibility requirements and application process. With thorough due diligence, developers can value each of the options and choose the one best for each real estate project.