Buying commercial real estate represents a smart investment for many business owners in Chicago, Illinois. However, obtaining financing for these purchases can be difficult, and choosing the wrong form of financing can place a significant burden on owners and their businesses.
Business owners should make sure they understand the variables that influence loan offers and the available sources of funding before they begin looking for commercial real estate financing.
Factors affecting loans
Borrowers should postpone applying for loans until they can provide proof of income and a sizeable down payment. Failing to do so can significantly affect loan availability or terms. Borrowers can research available loan options to estimate what kind of down payment will be expected. Borrowers with low or inconsistent monthly income can benefit from waiting to apply for loans when income is higher or more stable.
Loan-to-Value and Debt Service Coverage Ratio are two metrics lenders use when determining what sort of term and rate to offer. LTV is the loan amount compared to the value of the property. Some lenders will not approve loans with high LTVs, and others may charge higher interest rates or require borrowers to take out insurance. DSCR is the net yearly business income divided by total annual debt service costs. A DSCR that is greater than 1 is desirable, since it reflects positive cash flow. However, lenders may approve loans with a lower DSCR, if the borrower has additional external income.
Understanding LTV and DSCR helps business owners evaluate what kind of loan rates and terms they may qualify for. Borrowers with a high LTV or low DSCR will often need to apply for a greater number of loans to find one with favorable terms.
Sources of funding
Borrowers may apply for commercial real estate loans through banks, credit unions or specialized lenders. The Small Business Administration’s 504 Loan Program is another potential source of funding for commercial real estate purchases. Long-term 504 loans require down payments of as little as 10 percent, and the interest rate for 40 percent of the loan value is fixed. However, some businesses may not meet qualifying criteria for the program, and the loan terms may not be appropriate for some projects.
Borrowers should make sure to compare several options to find the most favorable loan rates and terms. Once borrowers have found funding and moved on to negotiating the sale of the property, they should make sure to work closely with an attorney with experience in real estate transactions. An attorney can help the buyer reach a favorable arrangement and understand the rights and obligations established in the loan and sales agreements.
