The question of whether to buy or lease commercial space is one of the most significant decisions that a business owner can make. If owning is the path you’d like to take, then this “how to” provides valuable information to help you prepare to buy commercial real estate.
The basics: Buying commercial real estate is different than buying residential real estate
Many entrepreneurs who consider buying commercial real estate have already been through the process of purchasing residential properties and they expect the same process.
While there are some similarities, there are several important differences:
- The length of time to pay back commercial real estate mortgages is shorter than for residential properties. While residential mortgages can be as long as 30 years, commercial terms typically run about 15-20 years. There are exceptions, though, and later in this article, we look at the U.S. Small Business Administration (SBA) 504 loan program, with terms up to 25 years.
- The interest rates on commercial mortgages are higher than residential real estate. The interest rates will also be adjustable every 3-5 years and there may be a balloon payment requirement in the 10th year. This is unlike most residential mortgages which offer a fixed rate for the entire 30 years and no balloon payment requirement. There’s variance among lenders and it’s worth your time to shop around to find the most beneficial combination of rates, fees and repayment periods.
- Most commercial mortgages require much higher down payments, often 20-30%. Special loans targeted to small business owners can help, including the SBA 504 loan.
- Unlike residential properties, environmental reports are usually required before loans can close on commercial property. This is something that catches new buyers off guard and that can add time and expense to the purchase process.
Key tips to prepare for the process
Now that you know the basics, here are steps to take as soon as (or even before) you’re ready to buy:
Step 1: Ask for an initial meeting with a loan officer at your
bank or other lending institution
Loan officers have been through this many times and can give you valuable insight and set realistic expectations. Your loan officer is your advocate within the bank and throughout the process.
Your loan officer will:
- Help you determine the appropriate loan amount, from ensuring that all costs are included to adjusting the amount if it’s too high.
- Have a good sense of the market value and whether the purchase price is reasonable for the property’s age, condition and geographic location.
- Identify the information needed to consider the application for financing and set expectations on the time and likelihood for an approval.
- Ask questions that you may not have considered, such as whether:
- There are environmental concerns that need to be addressed
- The tangible and intangible costs of relocating your operations have been factored into the loan amount
- There are building code or use considerations that may impact the scope and scale of your project
- You have a qualified advisory team together, including an attorney who is experienced in commercial real estate
Step 2: Reconvene with your loan officer to review the project in full
While an initial meeting can provide you with great insight, your loan officer will likely raise questions or issues that you hadn’t considered. Once you’ve got the additional information you need, meet with your loan officer again to review an updated project scope, timeline and budget.
Things that you’ll address may include:
- Estimates for renovations or additions, if applicable. Your loan officer can review the quotes and help determine whether your loan amount and timeline are feasible for your project.
- Initial documentation that shows that you and your business can handle the additional debt obligation that you’ll take on with a commercial loan. While this will be formalized during the application process, letting your loan officer know that you’ve considered this and factored it into your budget already shows that you’re proactive and responsible about additional debt.
Step 3: Review loan products that are right for you and your
project
If you have both the credit and business histories that make it likely that you’ll get competitive rates and terms, you can still benefit from exploring all the options available. And if you and your business don’t meet all of the criteria for your lender’s loan products, don’t despair!
There are great options available for early-stage businesses that may not have long financial histories and for borrowers who fall just outside of banks’ commercial-lending criteria.
There are also loans targeted to businesses owned by women, minorities and veterans, as well as businesses that are located in special economic-development zones. Some of these loans have beneficial repayment terms, like longer loan terms and low fixed-interest rates, to make repayment easier.
For all these reasons, even if you don’t think you’ll qualify or you’re not quite ready to apply, or if you’re qualified but want to explore all options, it’s a great idea to discuss various loans with your loan officer. You may be surprised by how affordable and accessible they can be.
One example is the SBA 504 loan program. This is a loan program developed specifically to meet the needs of business owners who want to buy, renovate or even build commercial properties for business use.
Among its many benefits, the SBA 504 loan program:
- Requires as little as 10% down, compared to 20-30% or more for conventional financing.
- Does not have a balloon feature and offers repayment terms of up to 25 years.
- Offers a fixed interest rate for the full 25 years, while conventional bank loans typically offer five-year fixed rate options that adjust to a different rate for the next five years.
Additional funding options
In addition to conventional and SBA loans, there are financing sources and incentives that can make it more affordable to buy commercial
property. These include:
- Industrial-development agency incentives
Industrial-development agencies are municipal, county or state-run agencies that exist to support economic development in their designated areas. Based on this goal, they offer tax advantages and incentives to spur construction or renovation of existing commercial properties. - Economic-development loan funds
As with industrial-development agencies, there are federal, state, county and municipal economic-development loans with targeted goals, such as the U.S. Department of Agriculture (USDA) programs for businesses. Programs like these focus on economic development in targeted regions (rural and underserved urban locations are common), so businesses located in these areas (or expanding or relocating to them) may be eligible for funding. They typically offer competitive interest rates and terms, too.
Get in touch to get the information you need
Our team has decades of experience with commercial real estate transactions and SBA loan programs. When you work with us, you’ll be better prepared at every step, from initial discussions to closing and beyond. Contact us today to learn more about how we can help you.
