Commercial real estate loans have not been immune to these more rigorous standards for commercial lending. In fact, in many cases, the requirements for getting a commercial real estate loan have become more stringent than residential mortgages.
There are five C’s that are considered when determining if you qualify for a commercial real estate loan:
- Character (your past experience and financial stability)
- Capacity (whether or not you will be able to repay the loan)
- Capital (how much money you have available)
- Conditions (the risk involved in making this kind of investment)
- Collateral (what can be used to secure the loan)
Character is the first C in Commercial Real Estate Loans. Character is all about the borrower and how the loan will affect their reputation. A borrower’s character has two components: moral character and financial character.
Moral character is a measure of how well a borrower will do on this loan. We look at things like the borrower’s history of paying back loans and other debts, their credit score, and any criminal history.
Financial character is less about whether or not someone pays their bills (though that is important) and more about whether or not they have the cash flow to cover the payments on this new loan. This means we look at things like how much money they make each month, how much debt they already have, and any other expenses they might have (like alimony payments).
Capacity and cash flow are two terms that are often used interchangeably. They’re both ways of describing how much you can handle at once, but they don’t mean exactly the same thing.
Cash flow refers to the number of things you can handle at once, whereas capacity is about the amount of time you have to get those things done.
For example, if your business has a high cash flow, it has more money coming in than going out—you have plenty of resources available for growth and investment. But if your business has a low capacity, it means that even though your cash flow is good, your employees aren’t able to do all the work they need to do effectively because they don’t have enough time or resources.
The third C in the Commercial Real Estate Loan is Capital. Lenders will often require that borrowers make a cash contribution to the deal. This means that you need to have a portion of the funds readily available in order to close on the loan. The amount of capital required varies depending on the property and lender, but it’s typically between 5% and 20% of the total loan amount.
The condition of your business or the property to be purchased is another C in Securing a Commercial Real Estate Loan.
From the moment you decide what commercial real estate loan you want to apply for, your lender will ask about the condition of your business and the property to be purchased. They will also want to know why you’ve chosen this location and what kind of plans you have for it.
The condition of your business can have a major impact on your ability to secure financing, so you must be honest with yourself and with your lender about how much work needs to be done before it’s ready for re-leasing or sale.
The term collateral refers to property that is pledged as security for a loan. A borrower can use collateral to secure a loan, and the lender will take possession of it if the borrower fails to make payments.
Collateral is particularly important in securing a commercial real estate loan. If you’re buying or refinancing an investment property, you may need to pledge some of your other assets as collateral for the loan.
In conclusion, the 5 C’s of commercial lending are an important consideration when planning to finance your next commercial real estate purchase. If you can meet these requirements, financing will be much easier to obtain.