Commercial Property Financing Options

Lock Richards, Commercial Real Estate Broker, Nevada CountyAre you interested in purchasing or selling a commercial property and curious about the financing alternatives available?  On a national basis in 2013, the most active commercial real estate lending sources and their market share were as follows: i) CMBS – Commercial Mortgage Backed Securities, 24%; ii) National Banks, 18%; iii) Government Agency (Fannie, Freddie), 15%; iv) Regional/Local Banks, 13%; v) Insurance Companies, 12%; vi) International Banks, 8%; vii) Non-bank Financial, 8%; and viii) Private/Other, 2%.  However, due to the relatively small average size of commercial properties in Nevada County, our local lender composition looks significantly different.  Three of the most common financing sources for commercial real estate in our local market are as follows:

1. Local, Regional and National Banks (including Credit Unions). After several recessionary years of tight credit and forced capital reserve requirements, banks now appear to be flush with available cash and aggressively looking to place funds. I would estimate the majority of third party financed deals in this area are completed by banks with a local or regional presence.

In recent years, due to high vacancies, weak cash flows, depressed values, and stringent lending requirements, there have been relatively few “investment” property purchases (i.e. the purchase of a leased property that is generating net income to cover the monthly debt service). However, as the economic recovery proceeds, banks are now looking more favorably on investor deals. Typical “conventional” loan terms for investment properties today might look something like this:

–   Loan to Value: 60 – 75% (meaning a sizeable down payment is required)

–   Amortization Period: 20-25 years

–   Loan Term:  5 – 10 years (loans are not typically fully amortizing and require a balloon payment or refinance at the end of the term)

–   Interest Rate: fixed or adjustable (recent fixed rates have been around 5%; adjustable rates may start a couple hundred basis points lower, but will adjust in line with a chosen“index” rate)

Far more common in recent years have been “owner/user” transactions where a buyer purchases a building in order to occupy all or part of it. Third party loans for owner/user purchases are most commonly “SBA” (Small Business Administration) loans. The stated purpose of the SBA is to aid, counsel, assist and protect the interests of small business concerns.  The SBA has two primary loan programs for small businesses – “7a” and “504”.  The 7a program incentivizes banks to make loans to small businesses by guaranteeing a portion of the loan. Typical 7a terms might look like this:

–   Loan to Value: up to 90%; $5 million max loan.

–   Loan Term:  up to 25 years fully amortized.

–   Interest Rate: Predominantly adjustable.

–   Occupancy: Borrower must occupy at least 51% of the building being purchased.

–   Use of Funds: to purchase commercial real estate (and/or a business), inventory, machinery, equipment, working capital, etc.

The SBA 504 loan program is really two loans packaged as one.  The first loan of up to 50% loan-to-value is typically with a commercial bank, and the second loan of up to 40% is via a government-backed organization called a “CDC”.  An SBA 504 loan offers businesses long term fixed rate financing with a very low down payment.  Sample terms:

–   Loan to Value: up to 90%; CDC loan portion $5.5 million max, total loan up to $20 million +

–   Amortization Period: up to 20 years fully amortized

–   Interest Rate: Fixed.

–   Occupancy: Borrower must occupy at least 51% of the building being purchased.

–   Use of Funds: purchase and/or improve commercial real estate, purchase machinery & equipment.

2. Seller Financing. Many local commercial property purchases are financed by sellers themselves.  Seller financing can simplify and shorten the escrow process and save the buyer money on appraisals and other lender fees – which may at times translate into a higher price for the seller.  However, seller financing requires that the seller have suitable equity in the property, and the seller risks having to take the property back should the buyer default.  Loan terms can be as flexible as both buyer and seller wish to make them.  Sellers are wise to obtain a meaningful down payment to cover all closing costs and to help ensure that the buyer will do their level best to avoid default.

3. Liquid Cash or Tax Deferred Exchange Funds. While perhaps not technically considered “financing”, many local deals are “financed” using all cash, often via a tax deferred exchange where funds from the “relinquished” property are exchanged into a “replacement” property, with the deferral of capital gains taxes normally due.  These “1031” exchanges are now increasing in popularity as property prices, especially in the Bay Area, returnto their pre-recession levelsallowingowners to once again sell at a profit.

Lock specializes in the leasing and sale of commercial/investment properties and has over 25 years of experience in the field, including over 15 years in the Grass Valley/Nevada City area. His “Commercial Property Review” newsletter, full of current Nevada County market trends and specific property details related to industrial, office and retail properties, is available at or by calling 530-470-1740.

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