Commercial Real Estate Loans: Types and Requirements

When You Need a Commercial Loan

Any property with five or more residential units is classified as commercial real estate for lending purposes. The same applies to office buildings, retail spaces, warehouses, and mixed-use properties. These properties cannot be financed with conventional residential mortgages backed by Fannie Mae or Freddie Mac. Instead, they require commercial real estate loans, which have different underwriting standards, term structures, and qualification requirements.

The threshold matters for investors scaling up. A fourplex qualifies for residential financing with all its advantages (30-year fixed terms, lower rates, lower down payments). A fiveplex requires commercial financing. That single additional unit changes the entire lending equation.

Types of Commercial Loans

Conventional commercial mortgages. Offered by banks and credit unions, these loans typically feature 5 to 10-year terms with 20 to 25-year amortization schedules. Interest rates run 6% to 9%, and most include a balloon payment at term expiration. Down payments range from 20% to 30%. The lender evaluates both the property's income (using DSCR, typically requiring 1.20 to 1.35) and the borrower's financial strength.

SBA 504 loans. The Small Business Administration's 504 program provides long-term, fixed-rate financing for owner-occupied commercial properties. The structure involves a conventional lender providing 50% of the project cost, a Certified Development Company providing 40% through an SBA-backed debenture, and the borrower contributing 10% as a down payment. Terms extend to 20 or 25 years with fixed rates. The catch: you must occupy at least 51% of the building.

CMBS (Commercial Mortgage-Backed Securities) loans. These loans are originated, pooled together, and sold to investors as bonds. CMBS loans offer competitive rates (often lower than bank commercial loans), higher LTV (up to 75%), and non-recourse terms. The trade-off is rigid servicing: prepayment is expensive (defeasance or yield maintenance), and getting loan modifications is nearly impossible because the servicer acts on behalf of bondholders.

Agency loans (Fannie Mae/Freddie Mac multi-family). For apartment buildings with 5 or more units, Fannie Mae and Freddie Mac offer agency commercial loans with favorable terms: up to 80% LTV, 30-year fixed rate options, and non-recourse. Minimum loan amounts are typically $1 million to $3 million, so these are best suited for larger multi-family acquisitions.

Underwriting Differences from Residential Loans

Commercial loan underwriting focuses heavily on the property's financial performance. Lenders will request a trailing 12-month operating statement (actual income and expenses), a current rent roll, and a pro forma projection. They calculate Net Operating Income (NOI) by subtracting operating expenses from gross rental income, then divide NOI by the annual debt service to determine the DSCR.

The borrower's personal financial strength still matters, but it carries less weight than in residential lending. Lenders look at the borrower's net worth (often requiring net worth equal to or greater than the loan amount), liquidity (cash and marketable securities), and real estate experience. A first-time commercial borrower may need a stronger personal guarantee or a more experienced co-signer.

Commercial appraisals are more complex and expensive than residential appraisals, typically costing $3,000 to $10,000 depending on property size and type. The appraiser uses income-based valuation (capitalization rate applied to NOI) as the primary method, supplemented by comparable sales.

Preparing for Commercial Financing

Start assembling your documentation well before you need it. Organize at least two years of personal and business tax returns, a current personal financial statement, a detailed schedule of real estate owned, and property-level financials for any existing investment properties.

For the target property, prepare a thorough analysis including the purchase price, projected renovation costs (if applicable), market rent comparables, expense projections, and your expected NOI and DSCR. Presenting this package to lenders demonstrates competence and speeds up underwriting.

Build relationships with commercial lenders before you need a loan. Meet with loan officers at 3 to 5 local banks that are active in commercial real estate lending. Understanding each lender's appetite for deal size, property type, and borrower experience helps you match the right deal with the right lender.

For general tips on getting approved for investment property financing, see Tips for Getting Approved for an Investment Property Mortgage.