Most Common Types of Commercial Real Estate Loans

1- Traditional Model Loans

A traditional model loan is the most common type of commercial real estate loan. It is similar to a residential property loan used to purchase a single-family home, which typically has a fixed rate over 30 years. A commercial loan, however, often has a shorter term (5 to 15 years) and a variable rate. When applying for a traditional commercial real estate loan, investors may be required to put down 25 percent of the purchase price. Prior to issuing a loan, the lender appraises the property and consults financial forecasts to determine whether the debt service can cover existing rates.

2- SBA Loans

SBA loans are small business loans partially guaranteed by the U.S. Small Business Administration (SBA) and issued by participating lenders, usually banks. These loans have tight lending standards, but their flexible terms and low interest rates make them attractive, especially to investors who have been denied traditional funding. Currently, the SBA offers two loan programs for commercial real estate investments: SBA 7(a) and SBA 504 loans. 

SBA 7(a) loans are more common and can be used to purchase or refinance owner-occupied commercial real estate at any amount up to $5 million. To qualify, investors must have good credit and put down at least 10 percent of the property’s purchase price. The term of the loan can be up to 25 years, and interest rates can vary based on current market conditions and the applicant's qualifications. 

SBA 504 loans are similar to their 7(a) counterparts; however, there is no limit to how much an investor can borrow. Investors must have good credit and provide a down payment of 10 percent of the purchase price. The term of the loan is typically 20 years, and the investor must occupy at least 51 percent of the property. Unlike SBA 7(a) loans, these mortgages are not funded entirely through a private lender. Instead, they are made available through Certified Development Companies (CDCs), nonprofit entities that promote economic development within their communities. Typically, a commercial lender funds 50 percent of the project, and a CDC finances up to 40 percent.

3- Commercial Bridge Loans

Investors may turn to a commercial bridge loan as a short-term financial solution. Because it is short-term (usually 1 year or less), this type of loan tends to have a higher interest rate than a traditional commercial real estate loan. The goal of the loan is to provide funds and sustain cash flow while an investor improves, refinances, or leases up a commercial property. It can also be used while an investor is waiting to secure long-term financing or to cover a balloon payment on a loan.

4- Commercial Hard Money Loans

Hard money loans are one of the most expensive sources of financing for commercial real estate – with interest rates between 10 and 20 percent. These loans are issued by private companies or individuals and typically require little proof that an investor can repay the loan. Instead, lenders are more concerned with the value of the property. This type of loan is secured using the property as collateral. If an investor defaults, the lender makes money back by selling the property. The approval process to obtain this type of loan is much faster since few underwriting regulations exist. However, the investor must repay the money in a short amount of time, usually within 1 to 5 years. 

5- Commercial Mezzanine Loans

Similar to a commercial hard money loan, a commercial mezzanine loan uses commercial property as collateral and allows the lender to convert debt into equity in the event the investor defaults. If the investor fails to pay off the loan promptly, the lender has the right to take a portion of the investment property and sell it to pay the debt. Commercial mezzanine loans can be structured in various ways, including junior debt, preferred equity, convertible debt, or participating debt.

Investors typically use junior debt as the second source of capital and repay it after the initial loan is paid in full. They can use this type of loan for new acquisitions or to further develop the property. 

Under preferred equity, investors receive certain privileges in exchange for investing. These privileges can include priority return of capital or a higher rate of return than “common” equity investors. In the event of a sale or liquidation, preferred equity holders generally have priority over common equity holders. 

Convertible debt occurs when an investor borrows money and plans to convert it into equity or ownership in a company at a later time. The investor and lender decide the type of equity and a set time when the loan converts based on the company’s value when the loan begins. Typically, convertible debts are paid with converted equity within 1 to 2 years.

Under a participating debt agreement, investors receive interest payments and a share of the rental revenue generated on a commercial property if it exceeds a certain amount. This type of debt is often used to finance properties that have reliable tenants. 

Regardless of the type of debt incurred under a mezzanine loan, lenders are considered secondary to the primary lender if the mortgage defaults. To account for the increased risk, the cost of mezzanine capital tends to be much higher than for a traditional loan.

6- Take-Out Loans

A take-out loan is a type of long-term financing that replaces short-term interim financing. For example, if investors use a construction loan to build a new property, they can use a take-out loan to replace the construction loan once the property has been fully built. This type of loan might require the investor to make smaller payments at a lower interest rate over a longer period. In exchange, the lender might require the investor to share a part of the rent earned from the property or a percentage of the gain acquired if the property is sold.

7- Permanent Loans

Despite its name, a permanent loan is generally not permanent, although it may last an unusually long time. A permanent loan is a first mortgage on a piece of commercial property and is offered by most commercial lenders. It most closely resembles a consumer mortgage with a fixed or variable rate. 

8- Blanket Loans

Investors planning to buy more than one property may want to consider a blanket loan. This type of loan makes it easier for investors to get financing for multiple properties rather than having to take out individual loans. However, blanket loans have some disadvantages. For instance, it can be difficult to sell off an individual property since they are all tied together. Moreover, if an investor decides to unload a property and fails to sell it at the expected price, all other properties may be in jeopardy since they are joint collateral.

9- Business Line of Credit

A business line of credit allows an investor to borrow a certain amount of money while charging interest only on the amount of money borrowed (like a credit card). A line of credit is unlike a traditional loan where investors are given a lump sum of money they pay back with interest in monthly payments. For sudden expenses, cash-flow needs, and major purchases, a line of credit allows investors quick and easy access to available funds.