Commercial real estate (CRE) is that branch of real estate that is used solely for business purposes and monetary gain. This includes retail outlets, office buildings, business parks, hotels, and residential complexes. Financing these business ventures typically comes from commercial real estate loans. These loans are secured by liens on commercial, rather than residential, property.
Differences between residential and commercial loans:
Individuals vs. entities
Just as with residential loans, banks and individual lenders are actively involved in handing out loans for commercial purposes. While residential credits are most often given to individuals, commercial advances are given to business entities such as corporations, developers, and partnerships. These entities are often formed for the specific purpose of owning commercial real estate.
Loan repayment schedules
The debt for a residential mortgage loan is repaid in regular installments over a fixed period of time. This makes it an amortized loan.
Unlike residential loans, commercial loans are paid over the course of 5 to 20 years from the day of procuring the credit. The amortization period is often longer than the term of the credit. The rates of interest the lender charges depends on the length of the loan term and the amortization period. The longer the loan repayment schedule, the higher the interest rates.
Interest rates and fees
Commercial loans are subject to higher rates of interest than residential credits. In addition, commercial real estate loans include fees that add to the overall cost of the loan. This includes fees levied on appraisals and credit application.
Prepayment on commercial real estate loans
If investors settle the debt on their commercial loan before its maturity date, they will be required to pay prepayment penalties. These penalties are of 4 types:
Prepayment penalty– This is calculated by multiplying the current outstanding balance by a specified prepayment penalty. It is the most basic of these penalties.
Interest guarantee– The lender is subject to a certain amount of interest, even if the loan is paid off early.
Lockout– The borrower is not allowed to pay off the loan before a certain specified period.
Defeasance– This acts as a substitute for collateral. Instead of giving cash to the lender in exchange for their collateral, they give new collateral.
In conclusion, residential and commercial real estate loans differ vastly from each other. When evaluating a business entities’ vie for a commercial real estate loan, lenders consider the loan’s collateral, the creditworthiness of the entity (owners), and the financial ratios.