When building a business, one of the most expensive expenditures you can make is purchasing real estate. Commercial real estate—whether you’re buying land, offices, apartments, or anything else—can cost upward of millions of dollars, and not many people have that much money on hand.
That’s why taking out a commercial real estate loan is an important option to consider. Small business owners, in particular, can’t tie up all of their capital in buying real estate, but the rewards for making the purchase can be too great to ignore.
That’s the power of debt: when used properly, you open up opportunities for growth that wouldn’t be possible otherwise.
Not every real estate loan option is a good fit for every venture. Some loans are quantifiably better than others—lower interest rates, longer terms—while others have quick turnaround times, getting you your money fast. And some lending options are just outright expensive, and you should avoid them unless you have no other options.
Here’s a rundown of the best loan types on the market for real estate businesses:
SBA Loans
There may be no better loan option on the market for small business owners, regardless of need, than a loan through the Small Business Administration. SBA loans are bank loans that are partially guaranteed by the SBA, giving small business owners an opportunity to borrow at rates that are often reserved for larger businesses.
There are several SBA loan types, but two, in particular, are best suited for purchasing real estate:
CDC/504 Loans
The Certified Development Company (CDC)/504 Loan Program is specifically for business owners that want to fund the purchase of major assets, such as real estate. Use cases outlined by the SBA include:
- Purchasing existing buildings
- Purchasing land and land improvements
- Constructing new facilities or renovating/converting them
- Purchasing of long-term machinery
- Refinancing debt in connection with expanding the business through new facilities or equipment
The loan rates and terms for CDC/504 loans are some of the best available. For commercial real estate, the repayment term on the loan goes up to 20 years, with a maximum interest rate of 5.32% as of this writing. The loan typically requires a 10% down payment, and the loan amount ranges from $125,000 to upwards of $20 million.
All SBA loans and bank loans will have stringent requirements, and CDC/504 loans are no exception. You’ll need to submit a lengthy list of documents, including business financial statements, a complete business plan, and a personal budget analysis.
7(a) Loans
The SBA 7(a) loan program disperses funds for a wide variety of uses, from working capital to purchasing inventory to purchasing or constructing real estate.
If using a 7(a) loan to purchase real estate, your loan term can extend up to 25 years. The loan size will max out at $5 million, however, and your interest rate will start at 7.75%.
The other main difference with 7(a) loans is that, while the CDC/504 program uses your real estate purchase as collateral, with this program you may be required to put up your business and/or personal assets.
Traditional Bank Term Loans
A term loan from a traditional lender like a bank is likely what comes to mind when you think of a business loan. It’s a chunk of money that you pay back, plus interest, over a set term—a few years, if not more.
Rates on these term loans are low, typically between 5%-7%. The repayment term depends on your needs. The exact terms of the loan will depend on your credit history and the strength of your business—whether you have a high credit score, how long you’ve been in business, etc.
Your local bank, especially if you have an existing relationship with them, could be a good place to start to find a business term loan that you can use to buy real estate. You are more likely to be approved if your bank knows you are an established business or are otherwise a good bet to repay your loan.
A bank loan may be more difficult to obtain than an SBA loan if you need a smaller amount of money (under $250,000), and you may need to put up more collateral.
Commercial Bridge Loans
If you stumble upon an excellent real estate opportunity that requires you to move fast, a commercial bridge lender can extend you the funds you need to make a quick purchase. The term on a bridge loan is six months to a year, and at the end of that term, you either repay the loan in its entirety or refinance it.
A bridge loan is an apt description for this product: It bridges the gap between your short-term needs and long-term affordability. Typically, business owners obtain a bridge loan and then refinance that loan with a bank loan or SBA loan when the latter options become available.
Interest rates on commercial bridge loans vary from about 5%-30%, but in the fast-moving world of commercial real estate, taking on that kind of debt may be worth the price if it means you can quickly obtain the money to buy the space next door or secure the perfect spot for your next location.
Some of the best-reviewed bridge loan providers include Quarterspot, Fundation, and Credibility.
Short-Term Loans
Also known as hard money loans, short-term loans also offer borrowers blazingly fast turnaround times. If you need to get money for a loan quickly, a short-term loan—with a repayment period maxing out at about 18 months—is a good bet. If you’re orchestrating a short-term deal, such as a fix-and-flip, this option might appeal to you.
Short-term loans also have the highest interest rates of any of the other options on offer, with a range from 10-30%. Simply put, it’s generally the most expensive.
The upside is that short-term loans are usually easier to obtain than bank loans—they have a lower minimum credit score and time-in-business requirements, for example. If you see an excellent real estate opportunity but don’t have the time (read: months) or the credit history (read: a FICO score below 700) to obtain a bank or SBA loan, this might be your best option.
These aren’t your only financing options. You can also take out a personal loan and use it for business purposes (including buying real estate), or look into crowdfunding on platforms that help businesses obtain real estate funding, such as ArborCrowd, Groundfloor, and Crowdstreet. (These sites are also good options if you want to become a real estate investor.)
What’s compelling about the loans listed above, however, is that paying them back will help improve your credit score. You may not be able to qualify for an SBA loan for this project—but take on a short-term or bridge loan, pay that off, and your resume looks a lot stronger for more affordable financing the next time around. And that’s how you start building a portfolio that other real estate moguls dream of.
The article has been contributed by Eric Goldschein from Fundera.