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Commercial real estate investments can be high-paying assets, especially in California where more and more business owners are looking to build their brands. Our state offers one of the best opportunities in the country for building your investments through working with business owners.
But how do you get started? The issue lies with securing the money needed to acquire a building. Many factors influence the financing process for commercial real estate, all of which you need to understand to make informed decisions.
Commercial Buildings Tend to Be More Expensive
If you compare the prices of residential real estate and commercial real estate, you'll find a significant difference between the two. Commercial buildings require more financial resources from investors, and that's because they differ from other property types in key aspects.
Materials
Commercial properties need to be built with specialized materials that offer more strength since the buildings are usually bigger and/or taller. High-quality materials are needed to support higher ceilings, more floors, heavy equipment, or complex HVAC systems.
Depending on the purpose and size of the commercial real estate, more measures add to the cost such as security systems, specialized electrical systems, and complicated plumbing infrastructures. The latter alone can already drive up the price of construction.
Location
As mentioned before, business in California is booming, making it a prime location for commercial investment properties. The higher demand will drive up the rental price, which is good news for you, but bad news for your upfront costs.
Commercial real estate properties are typically built in prime areas with high visibility and accessibility. If it’s positioned in a place with high foot traffic or central business districts, it only adds to their property values and will require a higher down payment from you.
Income Potential
Commercial real estate investors recognize the property's potential for income. For this very reason, industrial properties, office buildings, and other kinds of commercial property attract plenty of healthy competition.
The higher income potential justifies the more expensive purchase price and with the right strategies and market knowledge, you can easily pay off your commercial loans as you earn positive cash flow from your tenants.
Commercial Real Estate Loans are Harder to Get
Even if you are willing to venture into commercial real estate despite the price, it might be hard to find commercial lenders who will loan you the amount you need. As opposed to residential loans, commercial loans can get more complicated.
Higher Risk for Lenders
Even lenders with high-risk tolerance need to be careful with commercial real estate loans. Your investment’s profitability will rely on the business occupying it being successful. The real estate market for commercial properties can be more volatile in many ways, making commercial lending risky for investors.
Factors that can influence this include economic downturns, changes in consumer behavior, and the emergence of competition. If the tenant fails to make their business profitable, it might lead to a failure to pay rent or turnover costs, which in turn affects your ability to make loan payments.
Complicated Processes
Although residential properties require you to go through paperwork as well, commercial real estate comes with more complex underwriting. For instance, lenders tend to ask for extensive financial documentation involving business plans, financial statements, and lease agreements.
When you ask real estate agents or other professionals for a property appraisal, it will also cost you more since it can be more complex, which just adds to the expenses and effort that go into acquiring commercial real estate loans.
Larger Loan Amount
If your personal finances cannot cover a sizable amount of the down payment, you'll have to get a bigger loan. Compared to residential mortgages, the average price could be hundreds of thousands to millions of dollars more.
There are several types of commercial real estate loan types you can explore:
Traditional bank loans: These are considered the most common financing option. Due to the amount you’ll likely need, you’ll have to get the loan from a larger banking institution. This will come with stricter underwriting criteria compared to a residential loan.
Hard Money Loans: As far as loan options go, hard money loans should be reserved as a last resort due to their high interest rates compared to traditional bank loans. A hard money lender will put the interest rate at about 12%, which can be substantial considering the amount the borrower will need covered.
Commercial Mortgage-Backed Security Loans (CMBS): CMBS offers great rates and terms but comes with certain loan terms. In this case, the building you're purchasing should already have existing, stable cash flow to be eligible.
Residential Loans vs. Commercial Loans
Commercial loans are typically made with business entities with loan-to-value ratios in the range of 65% to 85%. The loan term can last between five to 20 years, but the amortization period can be longer than that. Furthermore, commercial loans have higher interest rates, higher down payments, and shorter loan terms, all of which can depend on the purpose of the building.
Residential loans are made for each borrower with higher loan-to-value ratios. The loan term ranges between 15 to 30 years and has lower interest rates by comparison. The minimum credit score will also be lower than 620 since residential loans tend to be smaller in amount, which makes it easier to find many investors willing to finance your investment.
Ensuring Profitability with a Property Manager's Help
Just as we ensure smooth rental businesses to pay off residential loans, you can also count on Blue Line Property Management to handle your commercial property. Whether it's an office space or an industrial building, we’ll always do our due diligence and ensure profitability.
Investing in commercial real estate is risky, but with the right help and guidance, you’ll be able to pay back your commercial loans and expand your real estate portfolio. We can advise you about your financing options and provide insight into the rental market for data-driven decisions.
Contact us to learn how we can assist you with your rental property journey!