Let’s discuss commercial lending, what a lender is looking for in you, and a little bit about types of loans. So without further ado, let’s get into it.
My company and I get a lot of questions about commercial lending and how to move from a residential property into commercial loans or how to finance for commercial real estate. Under the umbrella of commercial would be multifamily apartments, retail, retail plazas, industrial facilities, offices, and the like.
There’s a little bit of nuance, but it’s not as complicated as everyone makes it out to be. You always hear about different types of debt: mezzanine debt, bridge loan, construction financing. I’m going to try to put it all into three simple buckets when it comes to the type of lenders. I think that this will give you an understanding of the type of loans that, generally speaking, are being done on the commercial side.
3 Types of Commercial Lenders
The three lender types are:
- Commercial mortgage-backed securities (CMBS) market
- Regional lenders
- Agency debt
Here’s a little bit more about each.
The CMBS market is not going to be a large component. It’s basically what the movie The Big Short was predicated on—the great financial crisis. So, CMBS are pools of mortgages. What happens with those is the originators of those mortgages aren’t actually the ones that create the CMBS financial instruments. Think about it this way, it’s mortgages throughout the United States that get pooled, and Wall Street takes it as a financial instrument that pays out a certain return based on its overall risk.
So, the tranches will each have different levels of risk. If there are defaults in the mortgage pool, the people at the top usually won’t get hurt. It’s going to be the first one with the highest risk that feels it, then the second tier, then the third tier, and so on.
The reason I’m getting the discussion of this type of lender out of the way is because, for most people breaking into commercial real estate, you’re not doing this type of loan. You’re probably going to be in the $1 or $2 million value in terms of the debt. If you’re not, if you’re up at $10 or $15 million, congratulations! That’s unreal if that’s your first commercial deal.
Now, let’s focus on the main ones.
Regional debt is going to be the closest thing to if you’ve ever done a residential mortgage. It’s going to be you going to your bank or hiring a mortgage broker to find a loan. A lot of times these are going to be fairly conventional loans. They’re going to be an interest rate that’s not absurd. It’s going to be an amortization of five years or 10 years. Or you might do 20 or 25, it really depends on the market.
And this is just your vanilla debt. They will look at this as recourse debt as opposed to non-recourse debt. So, we don’t really like that, because they can not only take your property, they can also go after you personally. But I mean, everybody has to start somewhere when you’re scaling real estate.
Now, agency debt is going to be your Fannie Mae or Freddie Mac. The reason it’s called agency is because these are effectively government subsidized agencies. In Canada, the equivalent would be what they call the Canada Mortgage Housing Corporation (CMHC), and they will do a very similar thing that Fannie Mae and Freddie Mac do.
With this type of debt, it’s actually very good if you can get it. It’s actually the debt I have on an apartment building just outside of Toronto. It usually comes with a lower interest rate, and they’re usually a little more creative on how you can finance the property. The ability to be creative when pulling money out of the property a couple years down the road is going to be something that you’re going to be able to do with this agency debt.
So, those are the broad types of lenders and types of loans that you can get. But I think what’s more important to the BiggerPockets community is describing what you need to do to get approved. What does the practical process look like?
What You Need to Get Approved for a Commercial Loan
I’ll tell you from experience that you need to come in with a couple things.
1. You have to know what you’re investing in.
So, if you’re looking at a multifamily or if you’re looking at offices, you need to know that and know the markets that you’re actually looking into. When lenders are looking at people who are breaking into commercial real estate, yes, they will focus on the property, the rent roll, the economic feasibility, the area demographics. But a lot of times, they’re going to focus on you.
2. You need to have your finances in order.
So, having your finances in order is absolutely critical. If the financial component is a challenge for you—say you’re not making as much as you would like to make or your credit isn’t as good as you would like it to be—those are just opportunities for you to partner up with somebody else and let them solve that component (maybe you do something more on the operational side). But that’s absolutely something they’re looking for.
They’re going to look at and identify the people. Just as proof of that, a lot of times the loans that people get when they’re moving from residential into the commercial real estate world are going to be the type of loans that you might get approved, but they’ll have conditions.
I’m a perfect example that. What we did for the first apartment building we bought was we needed to actually have third-party property management. It was mandated as a condition of the loan for one year. We also had to have a review of our financial statements on a quarterly basis. It’s kind of like training wheels when it comes to lending.
So, what they basically did was said, “I will give you the loan, but we want you to abide by a couple of conditions.”
I still get the letters today. So, we did get the loan, but we had to abide by specific things. And that’s OK if that’s what it means to take you to the next step of your investing career. Then, hey, you know everybody has to do what they have to do to scale in real estate. It’s a really small price to pay to start getting that credibility to move onto the next level.
3. It’s best to work with a mortgage broker.
Lastly, I just want to say something on mortgage brokers. In the past, the first few properties I started investing in, I would just go to different banks. You call up a bunch of people; you try to figure out how to get financing. I’ve since evolved to now use virtually one guy. Sometimes I use a second one, but for the most part, one individual is the mortgage broker who finances most of my deals. And that’s what’s great.
You present them with a deal, and you say, “Listen, here’s my property, here’s the rent roll (get it off the broker who is listing the property), here’s the area. How much money can you give me?”
I literally do that about once a month. He’s probably sick of me, but you know, hopefully we can make him some money. So, mortgage brokers are great because they have the ability to shop a loan around to a number of different providers. That way, you don’t have to deal with going to 30 different banks and trying to figure that out.
Commercial Loan Resources on BiggerPockets
What BiggerPockets has done is compiled several different loan resources on the site.
One of them is CBRE, which is one of the largest commercial real estate companies in the world—if not the largest. They’ve got a huge debt department, so that’s one resource that will help you.
StackSource will help you source different lenders and compare them.
And Branch Equity has a number of different commercial lenders. Again, they will help you source deals.
Key Takeaways: Getting Approved for a Commercial Loan
Alright, just to wrap up here, we talked about three major lenders: the regionals, the agency debt, and the CMBS market. And in addition to that, make sure that when you’re looking for a loan, you know the asset type and you are coming in with your financials in good order or coming in with a partner. That’s going to be the person that they lend on.
Lastly, make sure that you come with a deal. Don’t just call mortgage brokers or go to banks. You don’t have to have it under letter of intent or under contract. You just need something that they can base their opinion on and give you advice about. Because at the end of the day, the first step to getting a loan is actually finding the deal and underwriting it.
Is there anything you’d like me to expand upon when it comes to getting approved for a commercial loan?
Ask me in a comment below.