Investing in commercial real estate is a big decision, but can provide many benefits and opportunities for your business. In this article, we provide you with all you need to know about making a decision to invest in (buy) a commercial real estate property, including considerations and types of commercial financing available. 

Common Reasons to Use Commercial Real Estate Financing

Commercial real estate loans are made to businesses looking to finance income-producing property. Some examples are office buildings, medical centers, malls, restaurants, retail shops, apartment buildings, hotels and warehouses. 

Common reasons you may be seeking commercial real estate financing could be:

• You are buying an office building to house your business, and may opt for leasing out space to other businesses (generate extra revenue).
• You are expanding or relocating a retail space for your store or restaurant.
• You are buying warehouse space to house your inventory.
• You are buying, building or renovating a hotel, you will operate yourself.

There are many reasons you may choose to buy your commercial space, but you may ask whether leasing is better than buying.

Buying versus Leasing Commercial Space

If you are short on capital, a lease can be a good way to get into a market and save to buy later while also testing out a location before committing to it. If you have the capital for a down payment and the means to finance your purchase, consider that real estate properties trend upwards in appreciation so you make a long-term good investment while having the opportunity to earn passive income and bring down your taxable income by deducting certain expenses.

PROS to Buying Commercial Real Estate Property

• Appreciation & Equity. Ownership in the property grows as the loan principal and interest is paid down, and the property grows in value over time, which can be used as collateral in the future or be sold for profit to fund future work projects.
• Tax breaks. Savings on tax-deductible depreciation can help offset property ownership costs (though the mortgage payment itself isn’t tax deductible).
• Rental potential. If you have space to rent out, you can do so as the owner and receive a passive stream of income.
• Control of property and management.

CONS to Buying Commercial Real Estate Property

• Higher upfront investment. A down-payment will probably be required to fund an initial commercial real estate loan. (loss of liquidity)
• Upkeep costs of ownership like property taxes, repairs and maintenance, which subtract from your profit.
• Added cost of Liability Insurance.
• Lack of flexibility since you have a mortgage commitment.
• Prepayment penalties on loans.

PROS to Leasing Commercial Real Estate Property

• No down-payment and lower upkeep costs since the owner usually takes care of repairs and maintenance (gross lease).
• Ability/flexibility to enter into a competitive real estate market. Rental prices and options may make it easier to open in a hot real estate market versus buying, which can be too expensive or difficult to find the right property to purchase.
• Flexibility. Stay or move after your lease contract is up. 
• Tax breaks. You may be able to deduct the entire monthly lease payment as well as ongoing costs such as utilities. Always consult your tax advisor or accountant first.

CONS to Leasing Commercial Real Estate Property

• No ownership. Your lease payments aren’t going toward you owning the property.
• High rent. Rent might be more than what you would pay in a mortgage payment.
• High upkeep costs. “Net leases shift more of the cost burden of repairs and maintenance from the landlord to the tenant.”
• Increase of Rent. Owners may increase your rent annually at their discretion.
• Loss of appreciation in increasing property value.
• Contract penalties, like breaking a lease early.

What Banks Are Looking For in a Borrower and What You Should Look For in a Bank

First and foremost banks will run a credit report on the business, and may want to secure a personal guarantee of the owners, so be prepared to authorize access to your personal credit report. Banks and lenders will also typically ask to review your business net worth (the difference between assets and liabilities), and income for both the business and owners (if different from business only income.) Your bank or lender will consider the potential income of the commercial property being purchased. They will also review the loan to value (LTV) of the commercial property being financed, and usually lower LTV is better as it means there is more equity in the property and will help with the financing and terms offered. 

It is important as the borrower that you review all repayment details, including terms, rates, fees, and amortization period. The amortization period is usually longer than the term of the loan. For example, you could have a commercial real estate loan for a term of 15 years with an amortization period of 30 years, followed by a final payment of the entire remaining balance of the loan. This structure helps reduce the monthly payment amounts. 

Ask your banker about all the documentation required to apply and get organized. The more you are able to provide, the faster the loan review process will be. 

Types of Commercial Real Estate Financing

You have several commercial real estate financing options available to you. Your financing will depend on your purchasing needs and credit capabilities. 

Here are some general details about each type of financing. Contact one of our bankers for details on what we can do for you and your business. 

Traditional Commercial Real Estate Loan

Ideal Uses:

• Owner-occupied property (Minimum 51% owner-occupied)
• Non-owner occupied property (e.g. apartments, mixed-use property)

Overview:

• First mortgage secured by commercial real estate
• Fixed & variable rate options
• Competitive Pricing
• Annual Fee
• Reduced rate with auto-pay

If you are not approved for, or have concerns about your credit situation, you should consider an SBA (Small Business Administration) Loan. SBA Loans are partially guaranteed by the SBA and offered by approved SBA lending institutions, like Home Bank of California. 

SBA 504 Loan

An SBA 504 Loan offers small business another avenue for business financing, while promoting business growth and job creation.

Ideal Uses:

• Purchase of existing buildings and improvements (Owner must occupy minimum of 51%)
• Expansion of existing building (Owner must occupy a minimum of 51%)

Overview:

• $125,000 to over $20 million
• 90% financing
• Low down payment (10% in most cases)

Eligibility:

• Existing for-profit, owner-occupied business (51% if existing building; 60% if new construction).
• Along with its affiliates, a tangible net worth of less than $15,000,000 and an average net income after taxes of less than $5,000,000 in the past two operating years.
• Liquid Resource Test – cash, marketable securities, bonds, and cash value of life insurance can not be greater than the project cost (does not include retirement accounts).

SBA  7(a) Loan

An SBA 7(a) Loan works best for smaller projects and is the quickest and easiest of the SBA loan programs.

Ideal Uses:

• Purchase of buildings, and expansion or conversion of existing facilities
• Purchase of an existing business 

Overview:

• Low down payment–Minimum down payment as little as 10%
• Longer terms & limited prepayment penalty
• Specialized Programs available for exporting companies, underserved communities, military and working capital needs

Eligibility: 

• Existing for-profit, owner-occupied business (51% if existing building)
• Along with its affiliates, a tangible net worth of less than $15,000,000 and an average net income after taxes of less than $5,000,000 in the past two operating years
• Located in, or planning to locate in, any area of the United States
• Liquid Resource Test – cash, marketable securities, bonds, and cash value of life insurance can not be greater than the project cost (does not include retirement accounts)

State of California Loan Guarantee Program

The State of California Loan Guarantee Program is a unique loan program that helps businesses create and retain jobs, and encourages investment in low- to moderate-income communities. The program is available to small businesses throughout the state of California.

Ideal Uses:

• Building Purchase
• Acquisition of Land  
• Renovation of Buildings

Overview:

• $1,000,000 – $25,000,000
• Commercial Real Estate Loans (must be at least 51% owner occupied): Guarantees up to seven years, loan terms can be longer.
• Proceeds must be used in the State of California.
• Bank determines financing structure and rate.

Eligibility:

• 1-750 employees
• Business must be one of the following entities: Sole proprietorship, Limited Liability Company, Cooperative, Corporation, Partnership, S-Corporation, Not-for-profit 

There When You Need Us

Contact a Home Bank of California Business Banker today to review your business financing options and see how we can help you grow your business.