Small business owner discussing a CRE loan

Making Sense of Commercial Real Estate Rates

10+ min read • Jan 22, 2020 • Grant Olsen

If you have small business needs related to real estate, you should probably consider a commercial real estate loan (sometimes referred to as a commercial mortgage). They’re specifically designed to help you leverage equity from your property to get money for retail space, restaurants, warehouses, or offices.

It doesn’t matter if you’re in the process of getting your business up and running or if you’re adding a 5th location for your established operation, these loans can be a real lifesaver. The amounts begin at $250,000 and can go as high as $5,000,000.

Some small business owners use commercial real estate loans to get out of a lease so they’re better positioned to launch the next stage of their property ownership goals. Other strategies include using the money to construct a new building, purchase an existing building, renovate an old property, or refinance for a better interest rate or an extension on your repayment terms.

A commercial real estate loan can have interest rates that begin in the borrower-friendly range of 4.25% and go all the way up to 30%. The purpose of this guide is to help you understand some of the factors that will determine the rate you might qualify for if you were to seek this type of financing for your small business.

The Nuts and Bolts of Commercial Real Estate Loan Rates

Financing has always been a popular way for entrepreneurs to cover all kinds of expenses related to starting, sustaining, or growing their businesses. When you seek any kind of loan, there will be an interest rate associated with it. This interest is how a lender makes their money. Without interest, they’d simply be running a nonprofit institution that generously shared money with you. No doubt this model would be popular with borrowers, but it would quickly bankrupt the participating lenders.

To keep the lights on, pay employees’ salaries, and save some money for their kids’ college funds, lenders always charge interest rates for commercial real estate loans.

Here are 5 key factors that can affect how much you might pay for the money you borrow:

1. The Riskiness of Your Venture

Lenders are naturally cautious when it comes to handing out money to borrowers. This restraint can be frustrating if you need money and feel like you’re not getting the right opportunities, but if they weren’t judicious, lenders wouldn’t even be around for you to request one of their loans.

Part of their due diligence will be to evaluate how you plan to spend the loan. If you’re purchasing an existing building in a safe area, you can anticipate a lower interest rate than if you were building a new structure in a volatile part of your city. And if you were renovating an 18th-century farmhouse, you could expect steeper rates than if you were simply expanding your current office.

Risks matter in real estate, and you’ll pay accordingly when it comes to your interest rate.

2. The Collateral for the Loan

When compared to other types of small business loans, commercial real estate loans often have some of the most borrower-friendly rates. Remember, they start in the neighborhood of 4%.

One reason for this low rate is that the real estate involved in the loan typically is used as collateral for the loan. Knowing there’s a tangible asset of value works wonders for lenders, as they’ll feel their blood pressure decrease substantially. Unsurprisingly, your interest rate will also decrease accordingly.

When your real estate is used as collateral and the value is strong, you can expect the best rates. If the value is less clear, or if you opt to use an alternate form of collateral, you will see a corresponding increase in the amount you’ll need to pay in interest.

3. Your Credit Score:

While some borrowers view their credit scores as the ultimate skeleton in the closet, lenders look at it as a helpful algorithm that predicts whether or not their money will be repaid. By taking into account your track record for how consistently and how substantially you’ve paid off your debt, they’re able to get a glimpse into the crystal ball and see how you’ll handle their money.

Because commercial real estate loans often have large dollar values, lenders are particularly interested in how the repayment process will go. If your credit score is high, you’ll be rewarded with a lower interest rate. For those who have mediocre scores, you may encounter high interest rates that serve as an additional safety net for the lender. And if your score doesn’t meet the required threshold, you won’t even be considered.

4. The Size and Term of Your Loan

When you borrow more substantial amounts of money, the lender will often want a larger guarantee to go along with it. So larger loans typically include higher interest rates.

Likewise, you will usually have a higher rate when your loan has a shorter repayment term because a shorter term has fewer payments baked into it, so it makes sense that the lender would want those payments to be larger. Even though each payment is bigger with a shorter repayment, you’ll still save money with that structure versus a long-term loan with a lower rate.

A prime example of this is a home mortgage. If you own a home, your mortgage likely has a lower interest rate than a comparable commercial loan rate. The reason for this is that mortgages usually have 30-year repayment terms. Commercial real estate loans, on the other hand, have terms of 20–25 years. Shorter terms will almost always have higher rates.

5. The Health of the Economy

External factors always impact interest rates. This can be exasperating because you’ll have no control over how these elements affect the amount you’ll pay for your loan. But there will likely be times when it plays into your favor.

During a recession or other economic downturn, you’ll find that interest rates are more favorable. For this reason, many entrepreneurs prefer to borrow during challenging economic times. On the flip side, interest rates increase when the economy gets back in gear and starts growing.

Defining Commercial Real Estate Interest Rates

Plenty of variables are involved with commercial real estate. Projects range from new construction to renovating dilapidated buildings, so it stands to reason that there are different types of interest rate structures that can accompany the related loans.

  • Loan-to-value ratio: Commonly referred to as the LTV ratio, this metric takes into account the loan amount compared to the property’s value. Lenders typically offer between 50% and 90%. So if the property costs $250,000 and the lender presents you with 50% LTV, the maximum loan value would be $125,000. When ratios climb higher toward 80–90%, you can plan on correspondingly higher interest because the lender is investing more significantly in the project.
  • After-repair value ratio: Known as the ARV ratio, this metric is similar to an LTV ratio but is used when the project involves renovations or repairs. The value of the property will be substantially lower at the onset of such projects, so lenders instead look at how much it will be worth when the work concludes.
  • Fixed rates: Set in stone for the duration of the loan, these rates can be desirable because the volatility of the economy won’t impact them. Of course, the best fixed rates are originated during times when market rates are borrower-friendly.
  • Variable rates: These rates can change according to current market conditions. Some lenders reset the rates monthly, while others will reassess the rates every 5 years. The details of the structure depend on multiple factors, including the creditworthiness of the borrower.

It’s crucial that you take all of these factors into consideration when approaching any real estate project that will require financing. Interest rates will always be a story of peaks and valleys, although the Fed tries its best to maintain stability.

“The Federal Reserve prefers to keep the fed funds rate in a 2% to 5% sweet spot that maintains a healthy economy,” says The Balance. “In this range, the nation’s gross domestic product grows between 2% and 3% annually, and the natural unemployment rate is between 4.5% and 5%. Price increases remain below the Fed’s inflation target of a 2% core rate. The fed funds rate was 2.25% as of July 31, 2019. There were times in history when the nation’s benchmark interest rate was well above this sweet spot to curb runaway inflation.”

You shouldn’t let the prospect of rising rates deter you from your small business’s real estate goals. Even if rates are higher when you seek a loan, that generally means the economy is performing better. In that scenario, the health of the market will bring ancillary benefits to your business. Lendio CEO Brock Blake explained the impact of inflation in a Forbes article:

“Another potential long-term benefit of rising interest rates? Improved margins. The underlying driver of a rate increase like this is inflation. When there’s mild inflation, prices for goods and services tend to move higher, giving small businesses room to increase their prices over time. With better cash flow and higher rates, you can improve your margins, leading to additional flexibility and breathing room.”

It’s important to note that even when you’re armed with robust information about commercial real estate loan interest rates, it can still be difficult to make an educated decision. This confusion is because various lenders will sometimes use their own pricing metrics, calculations, and disclosure standards.

“Real estate is extremely fragmented…no one owner is dominating the commercial real estate market (compare to Google Chrome’s 67% ownership of the browser market!),” says Forbes. “This has a huge impact on the ability to efficiently process transactions. In the next 3 to 5 years, lenders are going to either make everyone use a standardized template for underwriting deals, or use AI to create a ‘Rosetta Stone’ for translating between different financial models.”

The good news is that some free resources are available to help you translate loan details into a common language. One of these free tools is SMART Box™. It was created by experts from the Innovative Lending Platform Association in partnership with some of the top lenders in the industry.

“Access to capital is a top priority for NSBA and we appreciate how SMART Box allows small businesses to more fully assess and compare lending options,” says Todd McCracken, president and CEO of the National Small Business Association. “This type of price transparency, along with best practices like the ones adopted by the Coalition for Responsible Business Finance (CRBF), will help solidify the trust between non-bank lenders and small businesses.”

Getting Your Commercial Real Estate Loan

Some loans are famous for red tape. For example, if you’re seeking a Small Business Administration (SBA) loan, you can plan on piles of paperwork and an approval process that can drag on for up to 3 months.

Commercial real estate loans, on the other hand, offer a more streamlined process that is largely because your property will serve as the collateral. Any time you can minimize a lender’s risk, you’ll be rewarded with a simpler and more affordable form of financing.

“At the end of the day, the cutting-edge technologies that lenders are investing in today are going to make everyone’s lives a lot easier in commercial real estate,” explains Forbes.

So what are the considerations that will make or break your chances of getting a commercial real estate loan? Beyond what’s already been mentioned, lenders may look at these 6 financial factors:

  1. Personal credit: Lenders look at your private financial life to get an idea of how you handle those obligations. They’ll analyze factors like credit in use, payment history, amounts owed, and the length of your credit history.
  2. Personal debt coverage: Here’s a quick way for lenders to get a look at your spending habits. If your personal debt coverage is healthy, they’ll consider you more able to make payments if your business were to struggle.
  3. Business debt coverage: Carrying debt isn’t a problem unless that debt becomes too big to handle. By looking at your cash flow and debt payments, lenders will be better able to predict whether or not you’ll be willing and able to make your payments.
  4. Personal debt usage: If you have credit available, this metric shows how much of it you’re currently utilizing. It’s derived by dividing all your outstanding debt by your total available credit.
  5. Business debt usage: For this metric, lenders will compare your business to others in your industry and see if your amount of debt is reasonable when compared to your assets and revenue.
  6. Business revenue trend: If your business is on the rise, lenders will view that trend as an indicator for future success. By calculating the average revenue growth rate over time, they will see how it compares to other businesses in your industry.

To get a fuller picture of your project, most lenders will request project-related documents like property blueprints, property market analysis, purchase contract, scope of work, and project budget. Additionally, you may be asked to provide a resume, signed personal financial statements, projected financial statements, business licenses and registrations, commercial leases, and other documents.

If you want to improve your odds of approval for a commercial real estate loan, focus on bolstering your credit scores. Not only can this open more doors for you, but it will also be one of the most significant factors when it comes to the interest rate you will qualify for. When you’re able to get lower interest rates, you’ll easily save thousands of dollars during the lifetime of the loan.

The first step to improving your credit is to know what’s happening with it. Regularly check in with TransUnion, Experian, and Equifax to see what’s showing up on your report. Research shows that 1 in 5 Americans actually have mistakes on their reports, so don’t let yourself fall victim to this startlingly common situation. Any time you discover any errors, quickly take action to correct them.

You can also reduce the risk of blemishes on your credit report by signing up for automatic payments on all of your recurring obligations. In the hectic life of a small business owner, it’s easy to forget these kinds of details from time to time. So delegate the duty to a software solution so you don’t have to worry about it at all.

Every positive step you take toward improving your credit can have a corresponding effect on the interest rates you’ll get with your future financing. So do yourself and your wallet a favor by paying attention to your financial well-being. It’s the best way to gain some control of the situation and set your business up for success.

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Grant Olsen

Grant Olsen is a writer specializing in small business loans, leadership skills, and growth strategies. He is a contributing writer for KSL 5 TV, where his articles have generated more than 6 million page views, and has been featured on FitSmallBusiness.com and ModernHealthcare.com. Grant is also the author of the book "Rhino Trouble." He has a B.A. in English from Brigham Young University.