Do you want to get into commercial real estate?

21 Replies

Arguably, one of the 1st steps in commercial is to have a seasoned LLC to be able to get financing. I've been researching the main differences between traditional mortgages for residential and commercial lending and just found this great website at a lender website titled,

"Commercial Loan Requirements"

https://onenevada.org/loans/commercial-real-estate...

A current financial statement and a minimum of two years of tax returns (so you're going to have to wait til Year 3 before you can apply so better start that LLC NOW or look into buying an aged one) to include K1s on each borrower/guarantor. If the borrower is a business entity, please provide a copy of the articles of incorporation/partnership and operating agreement or copy of the trust agreement.

We will need a minimum of two years of income and expense statements, a current rent roll, copy of all leases and a copy of the fire insurance policy on the subject property (the things to ask from the selling broker).

The following third party reports will be required to complete the loan request, obtain loan approval and fund the loan. The borrower will pay for the following items:

  • MAI Appraisal?
  • Phase I Environmental Report?
  • Escrow and Title
  • UCC Search and Recording?
  • Flood Search/ Flood Insurance (if required)
  • Credit Reports (as in borrower, entity or tenant/s?)

What would be your game plan for getting into commercial financing?

Depends on the size of your commercial loan. I’m approved for a $150k commercial loan on a MF based on my personal credit & assets as well as the property. I just went through the process today to form the LLC and it won’t really exist for another 3-4 weeks.

Originally posted by @Dennis W. :

Depends on the size of your commercial loan. I'm approved for a $150k commercial loan on a MF based on my personal credit & assets as well as the property. I just went through the process today to form the LLC and it won't really exist for another 3-4 weeks.

Dennis, thanks for the post, can I pick your brain? What kind of MF, 5 units or more? How much was the required down? How did they calculate DTI, i.e. did they use the target's ROI and/or LLC debt? Can you use a one-member LLC without K1s? Thanks, John

Sure thing...

- 6-unit apartment building
- 25% down & any seller assist could cover closing costs but not my DP
- the rents had to be 1.25x of debt service & given 1st deal they wanted to see that I could cover the mortgage, insurance and taxes personally... I don’t know what DTI they were looking for but I was well below 40% with this mortgage payment
- LLC debt would have mattered if I had one stood up with debts.
- Yes it could be a single-member LLC. I am 51/49 with my wife.
- I recommend finding a credit union that lends commercially, within the region that your property is in. Odds are they will do smaller deals and work with newer investors, given the community/member focus.

I think I got that right about 1.25x... but I might be off there.

Originally posted by @Dennis W. :

Sure thing...

- 6-unit apartment building
- 25% down & any seller assist could cover closing costs but not my DP
- the rents had to be 1.25x of debt service & given 1st deal they wanted to see that I could cover the mortgage, insurance and taxes personally... I don't know what DTI they were looking for but I was well below 40% with this mortgage payment
- LLC debt would have mattered if I had one stood up with debts.
- Yes it could be a single-member LLC. I am 51/49 with my wife.
- I recommend finding a credit union that lends commercially, within the region that your property is in. Odds are they will do smaller deals and work with newer investors, given the community/member focus.

Dennis, thanks again for sharing the very helpful COMMERCIAL info. Can I ask some more Qs: is the title of the property going to be the LLC only and what would be the best exit strategy? When you say that "rents had to be 1.25x of debt service" can we assume that you mean GROSS rents so did ROI even get analyzed or used by the lender? What if the LLC had been aged and had both business credit and two years tax returns, would it have helped? What kind of interest rate is this and is that a mortgage or a commercial loan? Credit unions are a great piece of advice! Thank you again, John

I misspoke! I knew something sounded off. It was a debt service coverage ratio of 1.25. That is calculated as:

Debt Service Coverage Ratio = Net Operating Income / Annual Debt Service

The property will be titled under the LLC only. This is a long term buy & hold but I will just refinance it commercially as-needed. When I go to sell it would be just like any other commercial sale... I’m buying it from a LLC now.

This would have been more about the LLC if it had been operating for two years but I’d still be guaranteeing it even then.

Working it out now as a lot of options. Could be 5, 7 or 10 year term with variable or fixed rate & 20 year amortization/balloon. Another option is 20 year term with 5 year fix & variable after that. Rates prob be 5.5-7%, depending what type of option.

Originally posted by @Dennis W. :

I misspoke! I knew something sounded off. It was a debt service coverage ratio of 1.25. That is calculated as:

Debt Service Coverage Ratio = Net Operating Income / Annual Debt Service

The property will be titled under the LLC only. This is a long term buy & hold but I will just refinance it commercially as-needed. When I go to sell it would be just like any other commercial sale... I'm buying it from a LLC now.

This would have been more about the LLC if it had been operating for two years but I'd still be guaranteeing it even then.

Working it out now as a lot of options. Could be 5, 7 or 10 year term with variable or fixed rate & 20 year amortization/balloon. Another option is 20 year term with 5 year fix & variable after that. Rates prob be 5.5-7%, depending what type of option.

So the ROI of the target property had to cover 1.25x loan payments? That seems pretty steep! They didn't add in your own personal net income to help with that ratio? Did personal debt payments even matter? Congratulations on starting a LLC, getting into the commercial game, and finding a deal in this hot market that worked! Does your credit score impact determine the interest rate since the LLC is brand new and doesn't have a credit score yet? Thanks, John

I will throw it up on deal analysis as it seems good but not like blow-your-socks-off... would be curious of other opinions. My #s were off a 30 yr 6% rate with 25% down, conservative hold backs for vacancy, PM & maint. On PAPER it’s almost 18% cash-on-cash. But he’s giving me 6% back at close which helps.

My personal financial situation certainly is factoring in here. Before one question about property he wanted me to give an overview of my score, debts and assets. Especially assets... despite having statements showing about double the DP they still wanted my quarterly 401k statement.

Maybe the CU business mgr is a belt & suspenders kind of guy because the commercial mortgage broker I met with seemed less concerned.

I also almost got into a deal with a different seller where he had a strong relationship with a community bank where they were willing to let him carry a 2nd for the DP cash. But that was going to be a portfolio of property around $375-500k... we just couldn’t find a good price.

@John Acheson this article sounds like the picture perfect borrower for a lender... but doesn't paint an entirely accurate picture. You don't need a "seasoned" entity to purchase real estate with commercial financing. In fact, investors form new entities all the time right before purchasing a property. The difference here might be if you're considering recourse versus non-recourse financing. Unless you have an existing entity with a solid set of financials (i.e. you own a landscaping business that is looking to purchase a commercial building or you own an entity that already holds several properties), the majority of these commercial loans are going to need to be personally guaranteed by you anyway. You can buy it in ABC, LLC... but the mortgage docs will have you on the line if they have to foreclose on the property because you didn't make your mortgage payments.

When you're dealing with purchasing commercial properties, yes some of those different reports may be requested, but depending on the size of the property you're looking to purchase, they might not be relevant or necessary.  If you're looking at acquiring a mixed-use, 30 unit building for $3M then yeah... they'll require a full commercial appraisal, an environmental report (might not need a Phase 1 here depending on what a quicker environmental survey brings up), and the others are fairly standard for a commercial or residential purchase.  

The bank will most likely require the deal to be underwritten at a specific DSCR (usually 1.25 or higher as @Dennis W. mentioned). Banks want to make sure they get paid... and they don't want the deal to be too risky. In that example, your total NOI (so after all of your expenses should have been subtracted EXCLUDING your mortgage) should be no less than 1.25 times your annual mortgage payment. So to break that down... if your property has a NOI of $125K/yr, your mortgage payment can be no more than $100K/yr or (usually) 75% LTV (which breaks down to roughly $8,300/mo... or approximately a $1.6M property depending on terms).

There's a lot of differences between residential and commercial lending... but I promise they're not too complicated and your lender will be there to work with you and get you to the finish line.  Let me know if you have specific questions though!  Always happy to answer!  

Originally posted by @Matt Lefebvre :

@John Acheson this article sounds like the picture perfect borrower for a lender... but doesn't paint an entirely accurate picture. You don't need a "seasoned" entity to purchase real estate with commercial financing. In fact, investors form new entities all the time right before purchasing a property. The difference here might be if you're considering recourse versus non-recourse financing. Unless you have an existing entity with a solid set of financials (i.e. you own a landscaping business that is looking to purchase a commercial building or you own an entity that already holds several properties), the majority of these commercial loans are going to need to be personally guaranteed by you anyway. You can buy it in ABC, LLC... but the mortgage docs will have you on the line if they have to foreclose on the property because you didn't make your mortgage payments.

When you're dealing with purchasing commercial properties, yes some of those different reports may be requested, but depending on the size of the property you're looking to purchase, they might not be relevant or necessary.  If you're looking at acquiring a mixed-use, 30 unit building for $3M then yeah... they'll require a full commercial appraisal, an environmental report (might not need a Phase 1 here depending on what a quicker environmental survey brings up), and the others are fairly standard for a commercial or residential purchase.  

The bank will most likely require the deal to be underwritten at a specific DSCR (usually 1.25 or higher as @Dennis W. mentioned). Banks want to make sure they get paid... and they don't want the deal to be too risky. In that example, your total NOI (so after all of your expenses should have been subtracted EXCLUDING your mortgage) should be no less than 1.25 times your annual mortgage payment. So to break that down... if your property has a NOI of $125K/yr, your mortgage payment can be no more than $100K/yr or (usually) 75% LTV (which breaks down to roughly $8,300/mo... or approximately a $1.6M property depending on terms).

There's a lot of differences between residential and commercial lending... but I promise they're not too complicated and your lender will be there to work with you and get you to the finish line.  Let me know if you have specific questions though!  Always happy to answer!  

Matt, thank you very much for clarifying some of the commercial issues! Can I pick your brain further? How does personal income tie in to qualifying? I know that for residential it's DTI that drives the financing so in commericial are you both saying that it's the 1.25x EXCLUDING personal income and personal debt? I don't mind the personal guarantee part because my FICO is almost 800 but I had assumed that a seasoned LLC with several vendors and creditors on it's business credit profile with DnB and/or Experian would be a big help, but it looks like I'm wrong, and it's really about the NOI covering DSCR. With that said, let's say I'm trying to get started in the $200K or more range, is it better to have a seasoned LLC with great credit OR wait for the lender to determine a brand new entity structure that they prefer?

@John Acheson The difference between residential and commercial lending is generally a residential lender wants to make sure YOU qualify first and then that the property meets their criteria... whereas with commercial lending they want to make sure the property qualifies first and then you do.  Now both steps are important, its just a matter of how they evaluate each file that comes across their desk.

If for example, you're looking at an 8 unit building for $500K and you want to put 25% down on the property... well the building had better meet their 1.25 DSCR number first. It doesn't matter if your PERSONAL income is $50K/yr or $500K/yr, if that building doesn't have a NOI that meets their DSCR, they won't loan you all the money you're looking for.

At this stage of the game, there really isn't any substantial benefit to you having an LLC that's borrowing money with a non-recourse loan... because they still will take into account the LLC's track record when it comes to property acquisitions. If it hasn't done any deals... it doesn't matter if its been around 10 days or 10 years, they won't lend the money without a personal guarantee.

I'd look into having a discussion with a local commercial lender that can talk you through the process. Yes, you'll need to make a certain personal income, but more importantly, your deal needs to make a solid NOI and you need to have enough cash to put down to buy a property.

Originally posted by @Matt Lefebvre :

@John Acheson The difference between residential and commercial lending is generally a residential lender wants to make sure YOU qualify first and then that the property meets their criteria... whereas with commercial lending they want to make sure the property qualifies first and then you do.  Now both steps are important, its just a matter of how they evaluate each file that comes across their desk.

If for example, you're looking at an 8 unit building for $500K and you want to put 25% down on the property... well the building had better meet their 1.25 DSCR number first. It doesn't matter if your PERSONAL income is $50K/yr or $500K/yr, if that building doesn't have a NOI that meets their DSCR, they won't loan you all the money you're looking for.

At this stage of the game, there really isn't any substantial benefit to you having an LLC that's borrowing money with a non-recourse loan... because they still will take into account the LLC's track record when it comes to property acquisitions. If it hasn't done any deals... it doesn't matter if its been around 10 days or 10 years, they won't lend the money without a personal guarantee.

I'd look into having a discussion with a local commercial lender that can talk you through the process. Yes, you'll need to make a certain personal income, but more importantly, your deal needs to make a solid NOI and you need to have enough cash to put down to buy a property.

So are you saying that personal credit and income doesn't really matter in the beginning of the commercial analysis because the 1st step is making sure that NOI covers DSCR? If that's so, then how are they determining the interest rate used to generate the DSCR calculations because what I'm hearing is that personal credit score DOES NOT matter, LLC credit DOES NOT MATTER, etc? I still don't get the early steps of commercial pre-approval especially how to maximize credit to minimize interest rate?

@John Acheson - the interest rate you pay is going to be a concept of the prevailing rate for the market, the type of loan product you take out (shorter term loans usually mean better rates), your personal credit, your track record, and another host of factors that vary from lender to lender. The NOI of a property (and other factors: condition, location, etc.) will determine if you will even GET a loan. Your creditworthiness and of the other factors I named above determined how good the rates and terms of that loan will be for you.

When I'm personally budgeting numbers for a commercial loan for clients, I typically go between 5% and 6% interest over a 20YR term.  This is just what is typical in my market based on most of the clients I work with... reaching out to local lenders will help you get an idea of what you can expect to pay.  You can run your financial situation by a few lenders to see if they're okay with at a preliminary level, lending you money... but unlike residential, very few commercial lenders issue the popular "pre-approval" letter... because once again, they qualify the property first and the borrower second.  And they don't have all of the information they need up front on a property... that's what due diligence is for once you go under contract on the property you intend to buy.  

Unless you're a long-time customer or a very attractive borrower (maybe a well-established investor that has dozens of properties under ownership), you probably won't even know what the exact interest rate is until several weeks into a deal.

Originally posted by @Matt Lefebvre :

@John Acheson - the interest rate you pay is going to be a concept of the prevailing rate for the market, the type of loan product you take out (shorter term loans usually mean better rates), your personal credit, your track record, and another host of factors that vary from lender to lender. The NOI of a property (and other factors: condition, location, etc.) will determine if you will even GET a loan. Your creditworthiness and of the other factors I named above determined how good the rates and terms of that loan will be for you.

When I'm personally budgeting numbers for a commercial loan for clients, I typically go between 5% and 6% interest over a 20YR term.  This is just what is typical in my market based on most of the clients I work with... reaching out to local lenders will help you get an idea of what you can expect to pay.  You can run your financial situation by a few lenders to see if they're okay with at a preliminary level, lending you money... but unlike residential, very few commercial lenders issue the popular "pre-approval" letter... because once again, they qualify the property first and the borrower second.  And they don't have all of the information they need up front on a property... that's what due diligence is for once you go under contract on the property you intend to buy.  

Unless you're a long-time customer or a very attractive borrower (maybe a well-established investor that has dozens of properties under ownership), you probably won't even know what the exact interest rate is until several weeks into a deal.

Thank you VERY MUCH for the helpful commercial financing knowledge. This is VERY different from the standard residential mortgage that drives a lot of the deals on BP. Hoping this posts helps some investors break out of residential into commercial.

Here's some interesting relevant research from

http://www.c-loans.com/knowledge-base/debt-ratio-a...

"In real life, commercial real estate lenders almost never calculate the personal debt ratios of a commercial mortgage borrower. The overwhelming consensus is that if the borrower is wealthy enough to own commercial-investment property and he has good credit, his personal finances are almost certainly in order. While most commercial lenders will gather a financial statement and two years’ tax returns on each borrower, few Loan Committees spend more than 30 to 45 seconds flipping throughout them."

So it looks like personal credit matters more than personal net income and debt which is very different from residential approvals hinging on DTI.

And according to

https://www.askalender.com/advice/commercial-real-...

"What Is a Commercial Property Loan?

A commercial property loan, or commercial mortgage, is a specific finance option to purchase land or a property that is used for businesses or to produce income. Commercial real estate includes industrial, retail and office properties as well as mixed-use properties, restaurants and multifamily properties with five units or more.

Lenders typically prefer a DSCR of 1.2 or higher.

In general, to be approved for a commercial mortgage, you must have a credit score of at least 660."

I can't speak for all loans but I do commercial real estate day in and day out with clients buying properties in the millions to tens of millions of dollars in price.

The buyers I know do not have to have a seasoned LLC. There are tons of different entity structures to employ.

Also with regards to loan lender requirements are going to vary A LOT. You have a stabilized, half vacant, vacant property and all of them are underwritten differently. LTV also comes into play. The lower the LTV on a stabilized asset the more a lender tends to offer for a better rate and non-recourse as it is usually less risk to them.

Location of the asset is key also. Many of the prime lenders will only do strong suburban to urban core areas and will not touch weak suburban to rural locations. Those are generally local banks with more stringent requirements on loans as they know the are is more risky ( less population, less growth, older towns,lower median incomes, aging population for workforce, etc.).

At play also is the focus of the lender. Some lenders mainly focus on residential so if you go to them for commercial they give crappy terms like for example in today's market 5.3% interest rate, full recourse, 5 year term, 20 year amortization,35% minimum down. What this does is SUCKS DOWN any return for the owner investor and accelerates pay down to the bank on the loan. Great for them but typically sucks for the buyer. You have any blip with the property and the low amortization takes most of the cash flow coming in.

Conversely a lender more focused on commercial can get more competitive with terms. For example in today's market something like 10 year term fixed with 25% down at 4.9% and a 30 year amortization. If you go to 30 or 35% down likely partial to full non-recourse on the loan. This is what I am seeing for commercial retail properties. Various assets are underwritten differently.

It is important to source the debt and what that might look like when presenting an LOI to a seller /listing brokerage. You do not want to submit a price only to find out you can't land the debt you want.

@John Acheson - Factors that ALL commercial lenders will look at in regards to the borrower are FICO and liquidity.  Do you have the cash to do the deal and do you meet their FICO requirements.  Beyond that, lenders will have things specific to that lender.  Have you ever filed BK, had mortgage lates, foreclosures?  If so, how long ago?  Do you own your own home?  Do you live in the same state as the property?  What other RE do you own?  Do you have experience owning this type of property?  Etc...

Then they look at the property. It needs to meet their DSCR requirement. 1.25 is pretty standard as a minimum. Sometimes lenders will require higher. Like a Fannie Mae MF may increase the DSCR for smaller metro areas.

And then there's just a subjectivity factor.  You and the property may meet all the requirements, but the underwriter just doesn't like the deal.  Maybe they don't like the location, the neighborhood, the roof on the property....whatever.

So it's always good to have a Plan B lender or someone helping you who can take your deal somewhere else to keep it from be derailed.

Originally posted by @Dennis W. :

Depends on the size of your commercial loan. I'm approved for a $150k commercial loan on a MF based on my personal credit & assets as well as the property. I just went through the process today to form the LLC and it won’t really exist for another 3-4 weeks.

 What state is that? Are you mailing in a paper form? In Texas, we are confirmed within 2-3 days of a successful filing. Everything is done online...

I am in PA and my understanding is the documents are mailed. I could have paid to expedite. First one so I’m sure I took the long way. 

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