Buying commercial property for your small business can be difficult. Other than the qualification and underwriting process, understanding the interest and fees associated with these transactions can be a lot to digest.
Today, commercial real estate loan rates are currently low compared to past years. However, this doesn’t mean you shouldn’t do your homework. We’ll go over how the loan type, amount, repayment length and utilization combine with your credit score and other factors to give you an estimate of what you can expect to pay for your next small business property.
What Factors Determine Your Commercial Real Estate Loan Rate
Like a residential mortgage, loans for commercial real estate are based on multiple criteria. Your creditworthiness, the principal size and term, the current economy and other factors can affect quoted interest rates. Learning what lenders are looking for and how it applies to your situation gives you a basis to find the right lender that will provide you with optimal financing terms.
Like any other small business loan, your business and personal credit histories go a long way in determining what commercial real estate lending partners will work with you. Showing a long-standing ability to incur and pay off debt is attractive to lenders. Without it, you’ll likely qualify for funding with less favorable terms (if you can obtain any financing at all).
Banks and government-backed programs require strong credit scores (sometimes over 700). It’s possible for other lenders to work with you if you have a lower score, but the interest will get considerably higher. If you’re worried about being denied or given a high interest rate, make an effort to try to raise your credit score before applying for a commercial real estate loan.
The initial principal amount and length of your repayment term will be important in determining your interest rate. Generally, longer-term pacts will have lower interest figures attached to them, while short-term ones go up over 10 percent in some cases. Borrowers who receive longer repayment lengths are usually more creditworthy, and most short-term options are offered to less-qualified owners at an increased price. Similarly, those who can qualify for larger principal amounts will enjoy lower interest rates.
Current Market Rates
Current interest rates for commercial real estate loans are based on prime lending rates. These figures are tied to the economy and have been low and steady since the latest recession, and that bodes well for you since lenders use the most current data to determine what you’ll pay. For example, if you signed a contract today, a bank will take the current rate and add 1.5 to 3.5 percent based on your credentials as a borrower.
Lenders like the Small Business Administration and private investors also use prime rates to determine how high to peg the interest in your commercial real estate loan. Again, the increase that they apply will be in accordance to your creditworthiness and the financing terms you’re applying for.
Commercial Real Estate Loan Types and Their Interest Rates
With the emergence of online lending marketplaces, such as Fast Capital 360, there are more ways than ever to finance commercial real estate for your small business. Some, however, are harder to obtain than others.
Traditional Bank Loans
Banks are the gold-standard of commercial real estate lending. Generally, banks offer lower interest rates—5 to 7 percent—and more favorable terms than any other offer you’ll get, but they’re also the hardest to qualify for.
Banks also will offer up to 80 percent loan-to-value ratio, or LTV, meaning you would only be charged with coming up with 20 percent of the real estate’s cost on your own.
The Small Business Administration offers multiple programs that help owners, like you, finance commercial property. They’re put in place to open up access to funding for small businesses that do not qualify with banks. What the SBA does is “guarantee” a portion of a loan provided by a bank to mitigate the lender’s risk and help you get funding. That doesn’t mean they’re easy to obtain, however. You’ll need a strong credit score and business history to be approved, but there are great benefits to those who do.
SBA 7(a) Loans
The 7(a) program is the most popular of all SBA initiatives. There are many types of funding options under the 7(a) umbrella, and they encompass a variety of business uses, including commercial real estate. Guarantees on these funding options can be up to 90 percent based on the type, size and what you’re using the funding for.
Interest is dependent on the current prime rates, with a slight increase attached to them. Rates can be fixed or variable depending on your case and will get higher as your principal amount rises, but generally, fall between 7 and 10 percent.
CDC/ 504 Loans
Unlike their 7(a) counterpart, SBA 504 loans are put together strictly for fixed assets like commercial real estate. This program differs because it’s essentially fulfilled by two separate lenders. A Certified Development Company, or CDC, works with the SBA to provide 40 percent of the real estate’s total cost while a bank covers 50 percent or more. A 10 percent down payment is required by the borrower, although some may have to put down up to 15 or 20 percent.
The CDC-backed portions of 504 loans have interest fixed at a slight increase over the current Treasury rate, reaching around 4 to 5 percent. For the bank’s contribution, however, there is no set cap and you’ll have to negotiate the rates and fees. Generally, though, you’ll be able to receive an interest rate comparable to banks.
Online Marketplace Loans
If your small business is unable to meet the strict criteria for bank and SBA loans, online lending marketplaces may be your next best option for buying real estate. These companies facilitate your application and match you with the right lender, streamlining the process and assuring you get the best interest rate for your commercial property purchase.
These agreements generally come with an interest rate in the 8- to 12-percent range.
Hard Money Loans
Many owners are turning to private companies or investors for help financing their new property. Rates for these types of “hard money” commercial real estate loans are higher than any other, due to the fact that the lenders are incurring a great amount of risk working with less-qualified borrowers. You can expect to pay upwards of 20 percent interest if you need to turn to a private lender.
Short-term “bridge” loans are also commonly issued by private investors. With these, you’ll have a very-abbreviated term length as low as six months, after which you’ll have to either pay off the whole balance of the interest or, more commonly, refinance it with a bank or the SBA. No matter the length you’re offered, private lenders usually charge high up-front fees, further driving up your costs.
Loan Structures and Their Effect on Commercial Real Estate Interest Rates
Outside of what type of funding option you’re applying for, the way interest accumulates can change what you pay in total. Your lending partner can negotiate unique terms with you, but there are three common ways interest is worked into a contract:
Interest and fees are rolled into the principal amount and paid off in equal payments until the end of the term. Interest is front-loaded, meaning your payment will consist of less of the principal amount at the beginning of your repayment term. As the loan matures, you will begin paying down more of the principal balance.
Interest Rate Resets (Adjustable-rate Mortgage (ARM))
Variable-rate loans that have specified interest-reset dates. They’ll be fixed for a time (commonly 1-5 years) and then will reset based on the market on a schedule agreed at signing.
Common in Commercial Lending, the amortization period in this structure is longer than the total repayment term. Doing so leaves a large payment at the end of the term. Most borrowers plan in advance to either refinance their mortgage as the final balloon payment nears, or sell their property before the loan’s maturity date.
A Final Look at Commercial Real Estate Interest Rates
While we can give you an estimate of what interest rate you’ll receive for your commercial real estate loan, every case is unique.
According to the National Association of Realtors, the average for these transactions is between 5 and 7 percent. This number, however, is based on bank and SBA rates.
If you’re unable to qualify for these preferred lending programs, there are alternative options, though they do come at a cost. Some business owners prefer renting office space until their credit profile has improved because of this, so make sure to do your research to find out what you’ll qualify for and if you would be better off waiting before trying to buy commercial property.
If you think you’re ready to buy, you now have everything you need to know to ensure you can find the best interest rate for your commercial real estate loan. Go out and apply for yours today!