Finding the Right Commercial Real Estate Loan
The first step of any loan process is identifying the financing option that best matches your purposes. To do this, you’ll need to decide exactly how much money your project will require and how soon you’ll need to get that money. These 2 factors help to narrow the list of viable options and save you valuable time.
After reviewing your loan amount and timeline, you may find that a commercial real estate loan is the ideal solution. You’ll then need to figure out the costs of various loans in order to separate the top contenders for your business. This process is done by lining up comparable elements between loans.
“While there are numerous options from which to choose, not all deliver the same benefits,” explains Tom Coletta, a senior vice president at Axiom Bank. “Make a short list of potential lenders by shopping around to compare offers. As you go through the process, keep in mind that bigger isn’t always better—or safer.”
Be aware that some lenders will try to tack on hidden fees as well. Whether they’re buried in the loan disclosure as processing fees, late fees, early repayment fees, or whatever else, these sneaky add-ons should be located to give you an accurate view of the cost.
As you evaluate your best loan options, here are 4 popular pricing metrics that will help you break down the cost into manageable views:
- Annual Percentage Rate (APR): Anyone who has purchased a home or vehicle is familiar with this metric, which represents the cost of your loan on an annual basis.
- Total Cost of Capital (TCC): Sometimes it helps to get a macro view. With the TCC, you’ll see an overall cost that takes into account interest, fees on loans that don’t charge interest, plus ancillary fees.
- Average Monthly Payment: Because budgets are often viewed on a monthly level, this metric is helpful. Even if your loan were to have daily or weekly payments, you could still calculate those payments on a monthly scale.
- Cents on the Dollar: The simplest of all the pricing metrics, cents on the dollar breaks down the amount you’ll pay in fees and interest for every dollar you borrow.
While these metrics will give you a clearer view of your loan costs, they’re far from your only resource. Loan calculators are readily available and are a simple way to crunch the numbers and improve your understanding of various costs.
It’s important to note that your due diligence is sometimes hampered by lenders using inconsistent pricing metrics, calculations, or disclosure standards. This scenario can be frustrating, making it nearly impossible to make an educated decision because the facts you’re relying on contradict one another. It would be like trying to decide the best computer to buy, but each manufacturer listed the hard drive capacity, speed, and RAM differently.
“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 Rosetta Stone tools are already available for loan seekers. One of the most prominent examples is SMART Box™ (Straightforward Metrics Around Rate and Total cost), which was created by the Innovative Lending Platform Association in partnership with many of the industry’s leading partners.
SMART Box uses common language to make financing decisions more accurate. Going back to the computer analogy, it’s like putting different manufacturers’ specs on the same playing field, so you can clearly see which computer has the best hard drive capacity, speed, and RAM. You’ll also get a clearer picture of the pricing metrics for each loan.
“Finding funding to start or grow your business can be an onerous challenge for small business owners,” says Kristie Arslan of the Small Business & Entrepreneurship Council. “The growth of online lending platforms has provided small businesses with access to many more options in this tight lending climate. As a small business owner, allowing the vital information of a funding opportunity such as the monthly payments, total repayment amount, cost of capital, fees and much more to be pulled out of the fine print and presented with the SMART Box tool will greatly help me and other business owners compare options and make the best funding choice for our businesses.”
Getting Your Commercial Real Estate Loan
When compared to other forms of small business financing, commercial real estate loans are actually among the simplest to acquire. As mentioned earlier, this ease is largely because you’re using the property as collateral. By securing the loan with such a substantial asset, the lender won’t need to go to the same lengths in the application process as you might find with a financing option such as a Small Business Administration (SBA) loan.
Because the collateral is a key component of the loan, the lender will want to evaluate it and make sure the value is adequate. They’ll also scrutinize your credit, as it will help them decide if you’re a reliable borrower. Other important elements of the loan application include a written plan of how you will use the money, as well as purchase contracts, the property blueprints, property market analysis, scope of work documents, and project budget.
The exact requirements will vary from lender to lender, so it’s crucial for you to carefully prepare for the application and include every detail they request. If you neglect important aspects of an application, lenders will usually take that as a sneak peek into how you would handle their money if they were to lend it to you. By delivering a perfect application, you’ll always put yourself in the best position to succeed.
In order to be ready for whatever information is requested, it’s wise to assemble ample documentation in advance. That way, you’ll have everything ready to roll. Here is a comprehensive list of documents commonly requested:
- Personal background information such as education history, previous addresses, names you have used, and criminal record
- A detailed resume that presents your relevant business experience
- A robust business plan including profit and loss, proof of cash flow, and balance sheets from your business
- Credit reports from the 3 major consumer credit reporting agencies
- Personal and business tax returns for the past 3 years
- Signed personal financial statements
- Projected financial statements
- Personal and business bank statements for the past year
- The value of the property you will put up as collateral
- Business licenses and registrations
- Articles of incorporation
- Copies of contracts you have with third parties
- Franchise agreements
- Commercial leases
Improving Your Chances of Success
As long as you’ve properly prepared, your application should make it through the front door and get reviewed by the lender. They’ll evaluate your business plan, collateral, and other documentation to determine your qualifications. Additionally, lenders focus on these 6 financial factors:
- Personal debt coverage: Lenders will always be curious about your personal finances because of the many crossovers that part of your life shares with your business. If your personal debt coverage is healthy, it will suggest to lenders that you would be capable of making loan payments even in the unfortunate situation that your business were to go through difficulties.
- Personal debt usage: The vast majority of Americans carry personal debt, so it’s not a problem if you’re currently using debt financing. What matters is how much you’re using. By dividing your outstanding debt by all the revolving credit available to you, a lender can get a clearer picture of how you handle your finances.
- Personal credit: Your personal track record is most easily summed up in this simple algorithm. Lenders will pay close attention to your credit score because it takes into account relevant factors such as your payment history, amounts owed, credit in use, and your overall credit history.
- Business debt coverage: To see how well your business is set up for sustained success, lenders will evaluate your cash flow and debt payments. Your business debt coverage helps reveal your long-term ability to make the necessary payments for a loan.
- Business debt usage: Having a substantial amount of debt available to your business is a sign of financial strength. And using a moderate amount of that debt is an even better sign. Lenders compare your outstanding debt to your revenue and assets to see how it compares to other businesses in your industry.
- Business revenue trend: How does your revenue growth compare to the industry average? If you’re performing well versus comparable businesses, lenders will be more likely to work with you. A positive revenue trend speaks volumes for your ability to pay back the money you have borrowed.
Even when your personal and business finances are in great shape, don’t expect every loan application to be approved. The truth is, the majority of small business loans get denied. Because of this, it’s important to approach each loan with an open mind. If your loan is approved, congratulations. If not, you can always derive some learnings from the process and come back stronger the next time.
To give yourself the best odds for success, focus on your credit scores. Lenders rely on these algorithms extensively in the application review process.
“Lenders will want to review both the credit history of your business (if the business is not a startup) and, because a personal guarantee is often required for a small business loan, your personal credit history,” says BizFilings. “We recommend obtaining a credit report on yourself and your business before you apply for credit. If you discover any inaccuracies or problems, you can correct them before any damage to your loan application has occurred. If you can, find out which credit reporting company your prospective lender uses and request a report from that company.”
Credit report errors are surprisingly common. According to some reports, about 1 in 5 people have incorrect information on their reports. These mistakes might seem minor, but it’s important to remember that any mark against you is a mark against your financial well-being. And these blemishes can add up to become the difference between getting approved and getting denied by a lender.
Common credit report mistakes include:
- Your account being confused with someone else’s with a similar name
- Your account being messed up due to identity theft
- A closed account that is still being reported as open
- An account on which you’re reported as the owner when you’re just an authorized user
- Incorrect reports of delinquency
- The same debt being listed more than once
- Incorrect information being reinserted even after it was corrected
- An incorrect current account balance
- An incorrect credit limit for an account
To avoid this fate, you need to check with the major reporting bureaus on a regular basis. TransUnion, Experian, and Equifax have a lot of power, but you should never let them operate in the dark. Instead, proactively monitor your reports and take action whenever you encounter something fishy by submitting a complaint.
Another great strategy for helping your credit scores is to sign up for automatic payments whenever possible. This technique may sound overly simplistic, but it’s a proven way to avoid the preventable issues that plague many credit reports. Small business owners are incredibly busy, so it’s not surprising they sometimes forget to pay bills and other obligations.
By automating your payments, you remove the human element. If there’s not a method of automating the payment from the recipient’s end, simply add them as a new payee on your bank’s app. If all else fails, set up a reminder in your calendar. Although this scenario still requires a manual payment, at least you’ll get a monthly nudge that reduces the risk of accidentally missing a payment and getting a blemish on your payment record.
If you consistently find yourself dealing with credit issues, you should consider enlisting the services of a credit repair expert. They’re trained to find errors and come up with long-term strategies that will help you get where you want to be.
Whether you want to build a restaurant, renovate your event center, open another retail space, expand your warehouse, or something else entirely, a commercial real estate loan can be a great way to make it happen. And by crafting a solid plan, assembling all the necessary documentation, and carefully cultivating your credit, you’ll put yourself in a prime position to get approved so you have the financing necessary to succeed.