Whether this is your first time investing in commercial real estate or you want to learn how to do it smarter, the key is finding the right type of loan. In broad strokes, you can think of hard money financing as a short-term plan and a mortgage as a long-term strategy. But the two aren’t mutually exclusive. You can start with a hard money loan and convert to a mortgage later. Even if your business has the liquidity to purchase property without financing, that’s not always the wisest choice. Read on to learn more about CRE financing for your small business.
Hard Money Financing
A hard money loan is a loan that is secured by assets, usually from a private lender. For example, you can use a hard money loan to tap into the value of an existing property without liquidating the asset. If your multifamily housing property is worth $1M and you take out a hard money loan for 80% of the property’s value, you’ll receive $800K in financing. The loan eliminates the need to sell the first property before acquiring the second. But you can also build out your portfolio by retaining both properties.
Here’s a quick breakdown:
- Pros: Hard money loans enable fast property acquisition. They can be approved quickly, and you don’t need to wait to sell old property. These loans also work well for businesses that don’t have the credit to qualify for traditional bank loans.
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Cons: Hard money loans often have higher interest rates because of their short terms and higher lender risk. These loans also require collateral, which can present a barrier for businesses without many assets.
Acquisition
Hard money loans enable you to “buy and hold” or “buy and resell” property quickly. They make expanding your business easier, whether you need more space or want to take over more territory. If this is the first property for your business, you can use the new property to secure the loan. Hard money loans also give you an advantage in the market because you can make a cash offer.
Rehab
Hard money lenders can base your loan on the ARV or After Repair Value of the property, giving you more than its purchase price. You can then use the extra funding for the renovations. If you’re flipping properties, the faster you can get to work, the faster you’ll build revenue. Hard money lenders approve loans in a matter of days or hours versus the several days or weeks you might wait on a traditional mortgage. If you don’t plan to retain the property for 25 years, you won’t want to pay for a 25-year loan.
Bridge Financing
Bridge financing covers your immediate costs while you wait for another source of funding, whether it be a mortgage or revenue. Investors often use this financing for income-generating properties like hotels and rentals. The bridge loan pays for the cost of the property, which you can pay down once the property starts earning. Rehabbers use them to bridge the gap between their initial investment and the property’s resale.
Commercial Mortgages
Commercial mortgages are long-term loans designed for investors who intend to retain property for many years. In contrast to hard money loans, they don’t necessarily require existing assets to secure. If you’re looking at a loan from a bank, the SBA, or the USDA, you’re looking at a commercial mortgage. They often have amortization periods that outlast the loan term, reducing the interest you pay over the life of the loan. Since they’re less risky for lenders, they come with lower costs than hard money loans.
- Pros: Commercial mortgage payments are less than what you’d pay on a hard money loan, which lets you keep more capital each month. They also require lower down payments and have lower interest rates.
- Cons: Commercial mortgages take longer to approve and can have a lengthy application process, which isn’t ideal if you need to act fast.
Long-Term Ownership
The average commercial mortgage is 7-10 years with a 30-year amortization schedule. That makes them the best choice if you’re retaining the property in your portfolio rather than reselling. Longer-term loans – up to 25 years for an SBA loan – are also available to reduce costs even more.
Buying Over Time
Commercial mortgages allow you to build equity. As the balance decreases with each payment you make, the property appreciates, adding to your overall equity position. You can leverage that equity to finance other investments. With a variable-rate loan, you can potentially pay less for the loan overall than if you paid for the property all at once. That’s because your interest rate can drop over time.
Reducing Down Payment
Commercial mortgage down payments can be as little as 10% of the loan. That’s 10-20% less than a down payment for a typical hard money loan. That makes mortgages a better choice if you don’t have the cash for a large down payment. Lenders expect you to be around for the long term, so they view these loans as less risky.
Despite the differences in hard money loans vs. commercial mortgages, you might still wonder which fits best with your particular business’s overall goals. The easiest way to get over this hurdle is to meet with a broker. Our brokers save you time and money by matching you with the right lenders faster than you might find on your own. Because of our exclusive lender relationships, we can also find better deals.
Whether you’re investing for the short or the long term, a broker is your best tool to get it done right.
