Right now the commercial property market is far less liquid than its residential equivalent. The pandemic has caused financial distress to many industries and businesses, and this has had an effect on commercial property.
As it stands, there are more empty offices in cities such as New York than there have been for over three decades. This means that it can be difficult for commercial property owners to find tenants, sell their property, or find financing for renovations.
Many commercial property owners may be in the business of ‘flipping’, that is purchasing a building with the intention to make improvements, and then sell it quickly for a profit. While this is still viable, the pandemic has caused some financial difficulties for these investors.
When this happens, there will be a need for a cash injection which will often come from some form of financing, i.e. a loan. One way to raise cash is through a hard money loan. But what is this, and is it the best option?
Why would someone need a commercial property loan?
There are many things that an investor needs to know before getting into commercial real estate, and one of them is how to finance it.
Some people or businesses have enough liquid assets to be able to purchase a commercial property outright, and then lease the space or sell the building at a profit. Commercial property flippers often use the money from one sale to finance the next, but sometimes lending options are needed.
If a building was taking a long time to sell and the owner wished to purchase another in the meantime, they may seek out a short-term loan. Or, if a property flipper needed to perform extensive renovations before they can sell then they may seek financing too.
Some people may look to invest in the commercial real estate market but do not have enough capital, so they would look for a loan or mortgage. There are quite a few reasons why loans for commercial properties would be sought, and also a few options for the borrower.
What are the options for commercial property loans?
There are about half a dozen common options for borrowers and lenders, with one being traditional commercial mortgages.
These are in a way similar to residential mortgages. They are normally given out by banks and other lenders, and they can last up to 25 years. The loan will represent a percentage of the value of the building, maybe up to 80% but there are some things you need to know before getting a commercial mortgage.
Traditional commercial mortgages require a very good credit history, low debt, and a very strong business. The interest rates are preferential and will be within a few points of the Wall Street Journal Prime Rate.
However, they are harder to qualify for than other commercial property loans. The other options are listed here:
- Hard Money Loans
- Small Business Administration Loans
- Conduit Loans
- Bridging Loans
- Soft Money Loans
All of these types of loans have a purpose and some fit different borrowers better than others.
What is a hard money loan?
These loans are sometimes described as the last option or the last resort. However, they are an extremely useful option in the right circumstances. Hard money loans are designed to be short-term solutions and they are easier to obtain than bridging loans or commercial loans.
Hard money loans are secured against the property and will normally have lower LTV (loan-to-value) ratios than traditional types of loans. Some lenders though will set the LTV against the ARV, or after repair value, and different lenders set their own limits too.
Some lenders may only lend 50% of the LTV, whereas others will loan 70%. Traditional commercial loans may go substantially higher. The other differences between traditional loans and hard money ones are the interest rates and the length of the loan.
What are the pros and cons of hard money loans?
Anyone seeking a hard money loan is likely to be looking for a short-term, easy-to-get approved loan. Commercial loans have longer loan periods and may have stricter approval criteria.
Here are some of the pros and cons of hard money loans:
- Easier to qualify than some other options
- Secured against property
- Up to 70% LTV with some lenders
- Short term
- Short term (can be a plus as well)
- Higher interest rates than some loans
- Penalties for early pay-off with some lenders
- Low LTV ratios with some lenders
Another pro is the quick approval and closing times with the loans. DFW Hard Money loans can be approved the same day, and closing is usually performed within 24 hours.
Property flippers use hard money loans due to their short-term nature, and because they can get quick access to capital to continue renovations.
The other options available
Commercial bridging loans are one of the other options available if the borrower is looking for a short-term loan. These work along the same lines as a residential bridging loan.
A bridging loan could be used in the same way that a hard money loan would. The differences are that they can be harder to qualify, and they may need a down payment of up to 20%.
The other options available are conduit loans, Small Business Administration loans, and soft money loans.
The terms of these types of loans can often be negotiated, and the length of them can be much longer than bridging or hard money loans. The lenders are often only interested in minimum loans of $1 million and up.
The Small Business Administration has some options for commercial property investors. One of them is the 7(a) loan which is available for anyone looking to buy land or existing property, construct new buildings, or renovate. Loans are given out for up to $5 million and can be paid off over 25 years.
Soft money loans
These can be used in the same way that bridging and hard money loans can. The difference is they have stricter acceptance criteria and the borrower must have good credit. Applications will be scrutinized much more than with a hard money loan, but the interest rate will be lower.
Is now a good time to invest in the commercial property market?
One consideration for anyone looking at any type of commercial loan now is whether the market is in a good position.
With the pandemic forcing so many companies out of business, there may be less potential to find buyers and tenants. On the other hand, there may also be cheaper properties available as owners seek quick sales due to financial problems.
One thing that is true of commercial property investment, is that it has far better yields than residential buildings. According to NOLO, a commercial property could yield up to 12% per annum. Compared that to a residential property where the yield is more likely to be 1% to 3%.
Commercial hard money lending is designed to help borrowers over the short term. It is particularly suited to commercial property flippers and those whose credit ratings may not match a bank’s criteria.
The benefits are fast approval, quick closing times, and short-term options. The negatives include high interest rates, but they can suit some borrowers more than the other options.