Commercial real estate investing can truly be a lucrative business, but before you decide how to finance your purchase, you need to know what you are planning to do with the property. In other words, your exit strategy will determine how you’ll want to finance the property.
If you’re planning on holding the property for a short while like a fix and flip scenario, then you want to obtain a loan that has the lowest up front fees. The interest rate and payments on the loan aren’t that important because you, hopefully, will be selling the property quickly.
If you plan on keeping the property in your inventory for a substantial period of time, like a fix and hold scenario, then you would normally trade paying higher up front fees for a lower interest rate and payments. Over the course of the loan those lower payments will save you much more money then whatever up front fee you may have paid to get the rate.
Once you have determined your loan priorities, then it’s time to go loan shopping. Here are some places you will want to look.
The lending requirements for a commercial loan are significantly different from a residential loan. In commercial lending the properties loan worthiness is determined more by it’s income and expenses than it’s actual physical condition or location. Commercial lenders look at a property in terms of it’s ability to produce income to support its expenses and financing.
A traditional lender will want to see the income and expense statements for the property for the past three to five years. They will also want to determine what the NOI (Net Operating Income) for the property is. All of this is done to determine if the property is a sound financial investment. Once they determine if this is true, then they will look at the condition and use of the property as well as the financial and credit status of the borrower and make a final lending decision.
These are also known as creative financing lenders. One of the more common methods of creative financing is to assume the existing financing on the property. This is when you agree to take over the seller’s current loan/loans that exist on the property. Many commercial loans are freely assumable so you can do this without getting the approval of the lender.
However if the seller’s loan is not freely assumable then you will need to qualify for the loan with the lender. The benefits of doing this instead of getting your own financing on the property are when the seller has a very attractive loan on the property like a low interest, long term loan. If you were to apply for a loan you would not be able to get these favorable terms so assuming the sellers financing is very attractive.
Another method is using a Master Lease. This used with a seller who is looking to avoid paying taxes on the gain from the sale of the property right now but can’t use a 1031 exchange to delay the taxes. In a master lease the buyer agrees to pay the owner a set lease payment every month and in turn gets to run the property as if they owned it. The lease term can be anywhere from three to five years and will include an option to purchase the property at it’s current market value when the lease expires.
The benefit to the seller is he is only charged capital gains on the current value of the property and not the future value of the property when the deal actually closes. Of course if the property should decline in value during the course of the lease then neither party will want to exercise the option and ownership of the property will revert back to the seller who can then decide to sell it or enter into another master lease agreement. A master lease can also be good for a buyer as it gives them time to see if the property is going to be a good investment without having to take the leap and close on it immediately.
Another common creative finance technique is the Blanket Mortgage. This is where you offer the seller or traditional lender the added security of giving them a lien not only on the property in question but also on another piece of property you own. This means if you go into default on the loan then the lender has the right to foreclose on all of the properties they have a security interest in and not just the property you are buying. This type of incentive may get a lender to approve a loan they ordinarily would have denied.