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Commercial real estate (CRE) lending is a cornerstone of the banking sector, providing the necessary capital for businesses to invest in properties that support their operations. From office buildings to retail spaces, CRE loans are vital for economic development and urban revitalization. Understanding the various aspects of CRE lending, including the types of loans and lenders involved, as well as the lending process, is crucial for banking professionals to serve their clients and manage risk effectively.
A commercial real estate (CRE) loan is a mortgage secured by a lien on commercial property as opposed to residential property. Commercial properties might include office buildings, industrial warehouses, shopping centers, apartment complexes, and mixed-use developments. These loans are typically used to acquire, develop, or refinance commercial real estate. They are characterized by larger loan amounts, more complex underwriting, and a broader range of property types compared to residential mortgages.
Commercial mortgages are the standard form of CRE financing. These are long-term (permanent) loans used to purchase or refinance commercial properties. Commercial mortgages typically feature fixed interest rates and long amortization periods, making them suitable for stable, income-producing properties. They are secured by the property itself, meaning the property serves as collateral for the loan. During the underwriting process, lenders often consider the property’s income-generating potential and the borrower’s creditworthiness.
Construction loans are short-term, high-interest loans used to finance the building of a new commercial property. These loans cover the costs of land, labor, materials, and permits. Once the construction is completed, the loan is usually replaced by a permanent loan. Since completion of construction is necessary for the commercial property to generate income, a construction loan is considered a higher risk than an amortizing commercial mortgage.
Bridge loans are short-term loans that provide temporary financing until a long-term loan can be secured. They are often used when immediate funding is needed, but the borrower anticipates securing a more favorable, permanent loan in the near future. For example, if a construction loan is due once work is complete, there may be a need to “bridge” the gap between the end of construction and filling the commercial space with income-generating tenants.
Mezzanine loans are a hybrid of debt and equity financing, often used to bridge the gap between the senior debt (first mortgage) and the equity investment. They are subordinate to senior loans but offer higher interest rates and can be converted to equity if the borrower defaults. The whole point of a mezzanine loan is to have extra support financing additional costs that go beyond the original loan’s purposes.
Both 7(a) and 504 loans are government-backed small business loans offered by lenders who partner with the Small Business Administration (SBA).
SBA 7(a) loans are typically used for businesses looking to purchase, refinance, remodel, or construct property up to $5 million. Borrowers need to provide anywhere from 10 to 20 percent down for a maximum term of up to twenty-five years.
504 loans are funded by a Certified Development Company (CDC) and a third-party lender, making up around 90 percent of the loan. Borrowers need to provide a down payment of at least 10 percent. The maximum amount of a 504 commercial real estate loan is $5.5 million. Loan terms can range from ten to twenty-five years.
CRE lenders can broadly be categorized into two main types: cash flow lenders and equity lenders. Each type of lender has different criteria and approaches to financing commercial real estate projects.
Cash flow lenders focus on a commercial property’s income-generating potential. They assess the borrower’s ability to generate sufficient cash flow from the property to cover loan repayments. These lenders prioritize stable, income-producing properties and often have stringent underwriting standards. Examples of cash flow lenders include traditional banks, insurance companies, and Commercial Mortgage-Backed Securities (CMBS).
Equity lenders provide financing based on the value of the property and the borrower’s equity stake rather than solely on cash flow. These lenders often take on more risk and expect higher returns. Equity lenders are crucial for projects with higher potential returns and risks.
Most equity lenders are private equity firms that charge a higher rate to compensate for the lack of cash flow.
The CRE lending process for banks involves several key steps, each designed to assess the project’s viability and manage the associated risks. Here is an overview of the typical process:
The process begins with a meeting between the borrower and the bank’s lending officer. During this stage, the borrower presents their project, and the lender conducts a preliminary assessment to determine if the project meets the bank’s basic lending criteria.
If pre-qualified, the borrower submits a formal loan application and detailed financial documentation, including income statements, balance sheets, tax returns, and project feasibility studies.
The bank’s underwriting team thoroughly analyzes the borrower’s financial health, the project’s potential, and the collateral value. This step involves reviewing the property’s income potential, market conditions, and the borrower’s creditworthiness.
Based on the underwriting results, the loan application is either approved, conditionally approved, or denied. If approved, the loan terms are outlined in a commitment letter.
The bank conducts due diligence, including property appraisals, environmental assessments, and title searches. The borrower and the bank’s legal teams prepare and review the loan documents.
The loan is closed once all conditions are met and documents are finalized. Funds are disbursed according to the agreed-upon terms, and the borrower can proceed with their project.
Post-closing, the bank continues to service the loan by collecting payments, monitoring the borrower’s financial health, and ensuring compliance with the loan terms.
Navigating the complexities of commercial real estate lending can be challenging. With BankersHub’s CRE Lending in Today’s Economy webinar, we’ll review the entire loan process, including how it’s marketed, underwritten, approved, documented, “closed,” and monitored. The webinar will also explore the current commercial real estate market, identifying the supply and demand of today’s commercial properties. You’ll learn how banks process CRE loans, underwriting techniques, and how to handle documentation issues. All BankersHub webinars can be played back at your convenience, making it easy for banking professionals to get the training they need anytime. Register today to learn more about CRE lending!
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