Commercial real estate (CRE) financing can be cumbersome and most times very intimidating. Much of the problem for investors and developers is related to understanding the seemingly endless choices of lenders and loan products associated with their own terms, conditions, and suitability for various projects. This represents a highly complex scenario, which might further encompass confusion, missteps, and potentially prejudicial terms for financing that may impact the success and profitability of CRE investments. Knowing the fundamentals of CRE financing is based on becoming familiar with the different types of lenders and loan products available within today’s market. Key participants in CRE lending include traditional banks, credit unions, life insurance companies, and private lenders.
Each of these lenders has certain loan products to suit special needs, from acquisition and development loans to permanent financing and bridge loans. The following elements should be understood in order to effectively navigate the landscape of CRE financing: Banks and credit unions offer a wide array of loan products at competitive interest rates for stable, income-generating properties and for the well-heeled borrower. Life insurance companies, the pioneers of the long-term, fixed-rate loan, suit high-quality, low-risk property. Private hard money lenders may include individuals or firms that are ready to offer short-term loans on flexible terms, usually at a higher interest rate.
It is for this reason that they form a good choice for those borrowers who desire speed or whose projects do not necessarily click into place as conventionally as they should. Government programs—the Small Business Administration, Department of Housing and Urban Development—offer significantly better terms for loans dealing with specific types of projects, like multifamily housing or small business real estate. These would include acquisition loans, which are utilized in the purchase of existing properties; construction loans, which finance the building of new properties and usually convert to permanent loans upon completion of construction; bridge loans, providing temporary financing until a more permanent solution can be worked out; and permanent loans, which represent long-term financing through fixed or variable rate options used in either refinancing an already existing loan or financing stabilized properties.
Categories of Lenders
Life Insurance Companies
The first type of lender we will go over are life insurance companies. Consumers purchase longterm life insurance policies and this money is pooled by the insurance companies who then seek to place it for predictable returns. Insurance company loans tend to be more restrictive in nature and are only for the best quality borrowers with the least risky projects. Example lenders include AIG and Met Life.
CMBS Lenders
The second category is CMBS: commercial mortgage-backed securities. These institutions—the Goldman Sachses and the JP Morgans of the world—lend on commercial property, then securitize the debt. By this, it is meant that the debt is parsed into different tranches of bonds to sell to investors. These new securitizations are rated and then monitored by independent rating agencies, which gives objective information for the bond-buyers about their investments. The buyers of these bonds can differentiate their relative risk and return.
Debt Funds
The third category of lenders are the debt funds. A debt fund is an investment vehicle set aside to undertake investment in loans by way of direct lending and/or buying loans. Debt funds are one such construction loan option, and as might be expected, the cost of construction loans inherently will be higher than for stabilized, cash-flowing property since the debt fund is seeking a higher return for tolerating more risk. The nature of debt funds ranges wildly from being backed by large firms and groups of private individuals to everything in between, such as Blackstone.
Banks
The final, and most common, capital source are banks. Banks have large pools of capital from their deposit base, and they can lend on a wide array of project scenarios. Banks may be national, regional, or local, and often their lending criteria are tied to their own geographic focus. National banks may consider any region for a loan so long as the borrower fits their other lending criteria. Obvious examples include Wells Fargo, Chase, and Capital One.
Types of CRE Loans
Conventional Commercial Real Estate Loans
Now, to the key types of CRE loans. Traditional commercial real estate loans usually have terms of 5, 7, or even 10 years, which are amortized over 20, 25, or 30 years. They can either be recourse or non-recourse, with the latter providing interest-only periods. They are hugely used for normal traditional cash-flowing investments and are usually given directly by banks.
Commercial Bridge Loans
The second type are commercial bridge loans. Sometimes referred to as sources of short-term capital, bridge loans are often used while an owner is improving, refinancing, leasing, or otherwise executing a property transaction. Generally, the term of bridge loans is 6-12 months and the interest rate is higher than permanent financing.
SBA Loans
A third category of loans are SBA Loans. The Small Business Administration has two types of loans, SBA 7A and SBA 504, rumored to aid in the financing of new and existing businesses wishing to purchase or refinance owner-occupied commercial real estate. SBA 7A provides up to $5 million in financing under very strict parameters, while SBA 504 provides up to 90% of the purchase price regardless of deal size, provided other business qualifications are met.
Commercial Mezzanine Loans
The fourth type of debt is commercial mezzanine loans. Mezzanine financing is utilized to fill in the “middle” of a capital stack. Since mezzanine financing can be executed in so many various ways and can also combine both debt and equity, it might include junior debt, such as a second mortgage on the property. Junior debt is subordinated to the senior loan and is, therefore, usually paid out only after the senior loan has been paid. Preferred equity is also a form of mezzanine financing.
Preferred equity refers to an equity contribution to the entity owning the property with a preferential return that is paid ahead of distributions to the common equity interest in the deal. It is a more secured position relative to the other equity in the deal but still subordinate to the senior loan on the property. Another good example of mezzanine debt is the participating debt. In this case, the investors receive interest as well as a percentage of revenue reaped by a property above a certain level, including both the rental income and the sales proceeds. Compared with senior debt, like a traditional mortgage on the property, mezzanine financing is subordinate in all cases.
CMBS Loans
The last loan structure that we will go over today are CMBS loans. Commercial mortgage-backed security, or CMBS loans, are secured by first-position lien on cash flow-positive, stabilized properties. CMBS loans have a minimum loan amount of $2 million, although they usually way eclipse that. One of the most significant benefits of a CMBS loan is that it is non-recourse. They are also generally fully assumable, though there are typically fees associated with these assumptions. This structure is much less flexible from a loan payoff standpoint. The prepayment is typically tied to defeasance or yield maintenance—not some percentage prepayment fee.
