A mortgage loan is the main type of financing available for a commercial real estate purchase. The interest rate is important to consider, but other terms can also be critical to the success of the purchase.
- One of the most important terms is the loan-to-value ratio—the portion of the property’s value that the bank will finance. Banks generally offer to finance 75 to 100% of the value of commercial real estate, depending on the building’s condition, resaleability and other factors. Any shortfall must usually come from your company’s working capital or your personal funds. A higher loan-to-value ratio means more money remains in your company in the near term to invest in growth or cover cash shortages.
- A second variable is the amortization period. This usually ranges from 15 to 25 years for commercial real estate. A longer amortization period may be preferable because it means more money stays in your company’s hands now.
- A third very important consideration is the bank’s flexibility in terms of loan repayment. For example, you may be able to get a holiday on principal payments for one or two years post-transaction to absorb the cost and disruption of the move. Or, if a cash shortage occurs later, flexible terms could allow you to make interest-only payments for several months.
Note: The bank may also be able to roll some or all of the cost of renovations into the mortgage loan, particularly if they add value to the property. An example could be a green retrofit to make a building more environmentally efficient.
2. Working capital loan
Working capital loans are short-term loans, often amortized over about five years. They’re meant to help your business pay for investments in its growth, and are handy for both real estate purchases and leases. For example, you can use one to ensure your business doesn’t experience sudden cash shortages during a move to a larger space. It’s common for businesses to significantly underestimate moving and renovation expenses, leading to strains on working capital.
A working capital loan can also help you cover the costs of buying equipment, hiring sales staff or doing a green building retrofit. Working capital loans are generally unsecured. You can sometimes negotiate a principal holiday for the first six to 12 months of the loan.
3. Leasehold improvement loan
A leasehold improvement loan is a short-term loan (often amortized over about five years) that you can use to pay for renovations to a leased space. Depending on the value of the improvement, a bank may accept the improvement as collateral for the loan, which could result in a lower interest rate than that for an unsecured loan. You can sometimes negotiate a principal holiday for the first six to 12 months of the loan.
4. Equipment loan
If you’re planning to buy equipment for your new space, an equipment loan may be useful. Such a loan is usually amortized over the life of the equipment—typically, five to 12 years. The equipment acts as security for the loan.
5. Demand loan
A demand loan has no fixed maturity date. You can renegotiate it as your business situation changes, giving you added flexibility, or you can pay it back in full or in part at any time, without penalty. As well, the lender can require repayment of the loan at any time.
Demand loans can be useful for paying for a move, buying equipment or covering a temporary cash shortfall.
6. Line of credit
This is a short-term, flexible loan that you can tap quickly during a sudden cash crunch or to pay for renovations.
7. Vendor financing
An eager property owner may offer vendor financing to a buyer to ensure the sales goes through.
In general, bankers are most likely to approve a business loan if your business has a history of profits and solid cash flow, promising cash flow forecasts, a healthy balance sheet, a strong management team and business plan, and evidence of succession planning.