Commercial Real Estate Financing: Banks vs. Private Lenders

The Pros and Cons

Commercial Lending
Commercial Lending. canstockphoto

Anytime an individual borrows money there are an inherently some benefits and drawbacks. This is especially true of the commercial real estate industry where a property’s income potential and a borrower’s credit worthiness may not tell the whole story of whether or not a multi-million-dollar loan makes sense.

As a commercial real estate agent, however, it is your job to make sure your clients are well informed about all their financing options.

These include both traditional lending institutions like banks, as well as alternative solutions like private financiers.

Once your client is knowledgeable about his options, he can determine which terms would benefit him the most based on his current situation.

Banks

Pros
- Normally offer the lowest mortgage rates on the market
- Traditional loan qualification guidelines lower a borrower’s risk of default
- Loans can be long-term, spread out over 20 years or more

Cons
- Rigid down payment, income verification and credit score requirements
- Won’t often lend on non-conforming product types
- Lengthy approval process, with money taking as long as 90 days to be secured
- High pre-payment penalty fees

Of course, we're all familiar with the major banks who make loans both residential and commercial:

Private Financing

Pros
- No set lending requirements. The two parties can come to their own terms
- Funding can be secured extremely quickly
- Loan qualification process is often less complex and time-consuming
- Less money spent on fees and closing costs associated with the loan

Cons
- Loans traditionally come with higher interest rates
- A high return on investment is usually expected
- Most private loans are short-term
- Must show the property’s income potential
- Must create a realistic exit strategy
- The real estate one seeks financing for acts as the loan’s collateral
- Depending on the loan-to-value ratio, borrowers may need to cross-collateralize to obtain their full requested financing

Also called "hard money" lenders, you can find them in a web search, with some of the top results here:

There is plenty of money out there for commercial lending, but carefully compare all of the costs, including fees and interest.

Transactional Funding

A specialty lending niche that has grown considerably in the fix & flip boom is transactional funding. These lenders specialize in funding real estate wholesale and fix & flip deals, with the wholesale turnaround sometimes the same day, and fix & flip for just a few months. Some turned up in a Web search:

The money is out there. All the commercial borrower needs to do is to factor all of the costs into the deal and cover them with a nice profit to justify their risks. It is rare that an investor or fix-and-flip specialist can't find a funding resource, but the key is to control costs and not price their deal out of the market.

When re-selling to another investor, such as a rental property investor, margins tighten up, and the cost of transactional funding can be a significant portion of overall cost. It's not just about interest, as most of these loans are of short duration.

Some fees can run into the thousands of dollars. The good news is that you can quantify those fees in advance of commitment to a deal. Most of these lenders will also set you up with fast letters of proof of funding to speed up your deals.

Transactional lenders fill a niche with fix-and-flip investors. The experienced fix-and-flip investor will buy cheap and use the poor condition and rehab as the biggest profit component. There can be lots of room in the rehab, so there is room for the costs of a transaction loan. Just be careful if you haven't worked with one of these lenders to be absolutely certain of their fee structure.