There's More To A Commercial Real Estate Loan Than Interest Rate

When it comes to commercial real estate finance, the statistics are everything. Borrowers pay close attention to one number in particular: the interest rate. However, the cost of commercial borrowing is only one factor to consider. The actual question is what the borrower can do with the funds to increase his or her company's revenue. Don't only look at the interest rate when assessing a commercial real estate loan deal. Consider the following factors:

What are the characteristics of the property?

Risk is linked to interest rates. While a borrower's credit and financial status may be taken into account when determining interest rates on a commercial real estate loan, the property itself is the main emphasis. Low-interest loans will not be available to all asset classes. Lenders are more inclined to provide lower rates on fully stabilised properties.

How are the funds going to be used?

The cost of the loan becomes less important if the money is going to be invested in the subject property or the borrower's business and has the potential to generate more income. The ability to seize an opportunity is more crucial. In this case, timing is everything.

How long does the investor plan to keep the property?

Low-interest loans usually have longer durations because the lender requires a return on the cash. The secondary market buys a lot of these loans. To ensure that investors receive a predictable return, the lender may impose a prepayment penalty. The penalty effectively raises the interest rate if the investor sells the property during the prepayment term.

How much are the payments?

Although interest on some commercial real estate loans may be higher than the borrower desires, chances are it is lower than the compounding interest on unsecured business lines. Paying off those debts through a cash-out refinance on commercial real estate can lower payments, generating more cash for business investment to increase income.

What is being collateralized?

Recourse is another factor to consider when evaluating a loan offer. Where the property is serving as collateral, it essentially is tied up for the term of the loan. Typical lower-interest permanent loans offer a loan-to-value (LTV) of roughly 65-70%. That represents the equity that can be pulled out during a refinance. The difference (30-35%) is how much cash the borrower needs to bring to the closing table if the loan is for a purchase.

Once the property is encumbered, the equity that is tied up in the property is unavailable to leverage. To refinance or pull out more cash, the property must appreciate or the borrower must make improvements. A short-term loan at a higher interest rate may allow for a higher loan-to-value ratio — as much as 80% for some asset classes. Because the term is shorter — typically 1-2 years — the collateral will be released sooner.