- March 15, 2019
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Not all types of real estate investing are created equally. That’s not said to infer that one type is better than another, but rather to impart the importance of understanding the difference between residential and commercial real estate investments. If you’ve had a lot of success flipping houses in the residential market, it can be intriguing to think that you’ll do just as well in commercial, but securing a loan in a commercial market is a whole different animal that deserves your full understanding before diving in headfirst. Let’s take a look at eight major differences between the two.
In the commercial real estate market, lenders aren’t just looking for your last few months’ pay stubs and your prior year’s taxes, as is typical in residential loans. While the applicant’s personal credit will certainly be pertinent in the decision-making process, as well as any history of liens, foreclosures, or lawsuits, there is also a lot of additional emphasis given to the actual net worth of the applicant. Lenders will want to determine that the applicant has a net worth that is equal to or greater than the loan amount, as well as having at least nine months of interest and principal in cash available to them.
Valuation of Property
Both residential and commercial real estate properties are valued differently, as well. While both depend on the state of the current market, the sale of nearby comparable properties in the area, and the desirability of the property in question based on location, accessibility, and the current structural and aesthetic state of the building, commercial lenders also must take into consideration the property’s performance. Namely, they will be looking to ensure that the asset has the ability to make a profit for the applicant based on its occupancy rate over the course of the past few months. Appraisal reports will be required in both instances, although commercial appraisals are typically much more expensive and take quite a bit longer.
In residential properties, it’s not unheard of to secure a zero-down financing option in a good market. A commercial property, however, will not offer such a luxury to an applicant. Lenders in the commercial market will require at least 20% down (with the cost of commercial property being much higher than the average residential property), and will require an 80% loan-to-value ratio.
The length of loan terms is also quite different when looking at residential and commercial loans. Residential loans can range anywhere from 15 years all the way up to 50 years, and have the ability to be refinanced and renegotiated throughout the course of the borrower’s lifetime. Commercial loans, on the other hand, typically come in around 10 years.
In the residential market, it is certainly not frowned upon to pay off your mortgage early (and, in fact, is often encouraged by many financial planners). In commercial real estate, though, prepayment could end up costing you a pretty penny! Most commercial loans frown upon prepayment, largely due to the fact that they are depending on a certain amount of residual income over the life of the loan due to interest rates. Most commercial lenders, therefore, instill a hefty fine for prepayment of any loan.
The whole process of finding a loan is different in the commercial and residential markets as well. While residential loans can typically be handled by any bank, regardless of size, commercial loans will want to look for a lender who meets their specific needs. A bigger loan will require help from a bigger, more prominent bank in order to achieve approval, while it will likely make more sense to take smaller commercial loans to smaller commercial banks.
Lastly, the penalties for not following through with your loan agreement can be much more detrimental in the scenario of a commercial real estate loan. In residential loans, yes, you will eventually lose your property due to non-payment of a loan, but your other personal assets are largely protected. In a commercial loan situation, not only will you face losing the property, but you may also be held personally liable for anything left unpaid.
Looking for Commercial Real Estate Investments in Baton Rouge or the Surrounding Areas?
Now that you have a better understanding of what makes a commercial real estate loan different from a residential loan, it’s time to find the right commercial property to begin your investing adventure. At SVN | Graham, Langlois & Legendre, LLC, our team of top-quality Advisors is ready and waiting to get you started! We’ll walk you through the commercial real estate process from start to finish, answering any questions that arise along the way. Take a look through some of our available commercial properties today and reach out to start looking!