If you plan to invest in a commercial property, you are probably aware that the financing structure can affect your bottom line significantly. You should also be aware that there isn’t a universal financing structure that can work for anyone.
Depending on the scope of the project, repayment strategy, and the intended final use, there are numerous options available to you. Below are 9 viable options when it comes to getting financing for a commercial property deal.
- Small Business Association (SBA) Loans
SBA loans are of two main types: 7A and 504. SBA 7A loans are 90 percent government-guaranteed bank loans. The 504 loan is a 50 percent first bank loan and a 40 percent second government loan also referred to as a debenture. SBA loans have their pros and cons.
The advantages of both loan types include fixed interest rates, small (10 percent) down payments, available from several lending sources, and the ability to finance building improvements. The downsides of both loans include the prepayment penalties, origination fees, personal guarantees and collateral, the number of years in business, and the business requirements of profitability.
- Conventional Financing
Conventional financing refers to traditional loans from local financial institutions. It is the commercial property funding option that most closely resembles a traditional residential mortgage. The loan comes with a fixed term and a variable or fixed interest rates, which is typically lower than interest payments available from other sources. However, this financing option is least likely to be available to you if you don’t have significant holdings.
- Construction Loan
A construction loan is a short-term loan used for funding the construction of commercial real estate in Philadelphia. The intention of developers that take out construction loans is usually to replace the funding with cheaper and longer-term money after construction is complete and it has been leased up. Banks usually release part of the proceeds of construction loans once funding has been approved while the rest is released periodically while construction is still ongoing.
- Equity Financing
Equity financing is where the owner gives up equity in a particular project in exchange for money to help in financing it. Equity transactions often make deals more economical compared to loans with interest payments. However, owners are giving up part of their profits and possibly even a level of control over the project. Non-traditional lenders typically offer hybrids of equity and debt funding, including mezzanine funding whereby the lender provides debt capital, but with the right to convert it to a stake in ownership of the project should the money not be paid back in full.
- Bridge Loan
A bridge loan is part of the short-term, non-bank loans. It is a form of financing used as a bridge to a longer-term mortgage. Short-term here refers to a period ranging between 6 months and 3 years. The interest rates on bridge loans tend to be quite high and the loans often involve interest-only payments until maturity. Borrowers usually expect to refinance into a longer-term and economical mortgage upon the expiry of the term of a bridge loan.
- Government Sponsored Enterprises (GSE) Loans
Fannie Mae and Freddie Mac are government-sponsored enterprises that play a critical role in funding multifamily housing projects. A GSE does not lend money directly, but rather buys loans from banks thus giving lenders the incentive to make apartment loans that may otherwise be deemed too risky. GSE acquired loans are subsequently packaged then securitized for sale in the secondary market. GSEs also promote the construction of low-income housing by purchasing and securitizing loans for affordable-housing projects, which are usually exempted from the annual limit that congress imposes on the overall loan purchase business of GSEs.
- United States Department of Agriculture (USDA) Business & Industry (B&I) Loans
The USDA’s Business and Industry program offers loan guarantees for commercial mortgages among other business activities. It is not just farmers that qualify. The key requirement is that the enterprise to be funded has to be set up in a rural area and create jobs. The term rural area as used here refers to an area with a population of less than 50,000 people and not part of an “adjacent urbanized area”. Using a search tool on the USDA website, you can find out whether your preferred property is within the qualifying area. The B&I program is similar to SBA 7A since banks make the loans and the USDA guarantees part of each individual loan.
- EB-5 Loans
The EB-5 immigrant investor program offered by the United States government promises permanent residency to foreign nationals that invest $500,000 or more in an enterprise that results in the creation of at least 10 jobs. The money from the EB-5 project has been used to fund massive projects such as the $20 billion New York City’s Hudson Yards mixed-use development. The jobs requirement is what makes funds from the EB-5 program useful for financing labor intensive properties such as hotels. Project owners seeking capital and EB-5 investors can collaborate through regional centers. The regional centers are entities that the United States Citizenship and Immigration Services sponsors, which facilitate financing for projects that qualify for EB-5 money.
Crowdfunding is one of the latest entries in the world of commercial property funding. It uses the Internet as a tool for reaching out to an audience of potential investors and matches them with potential borrowers. It is now easier than ever to market crowdfunding opportunities to accredited investors after the federal JOBS Act was passed in 2012. Crowdfunding lenders price the loans based on risk and evaluate potential investments. Crowdfunding is used for raising money for various commercial investments including real estate projects.
The Bottom Line
The important thing is to ensure that you choose the right funding option for your needs. If you are not sure about which option to choose, you should consult a commercial real estate professional.