Understanding Commercial Real Estate Mortgage Rates

David Cohn
Nov 7, 2020

If you own a business, buying commercial real estate to run your operations may be more prudent than leasing a property.

The right property lets you build equity and enjoy some tax benefits. You may even find commercial real estate mortgage rates as low as 3.9 percent, which could make purchasing property more affordable while possibly providing long-term savings, too.

Commercial real estate mortgage rates will change, so it’s a good idea to keep track of them as you select a loan.

Before you check the latest rates, it’s essential to determine the best lending option that will suit your needs.

Commercial Real Estate Loans - What are Your Options?

For most borrowers, conventional small business loans may be sufficient. These loans come from financial institutions such as credit unions and banks.

However, you may also consider SBA-specific loans and other options that provide funding faster, such as construction, hard money, and bridge loans.

Here is an overview of the popular commercial lending programs:

SBA 504 loans

Many borrowers want this loan because it is affordable, but it also tends to be the most difficult to get.

The SBA 504 loan was designed to encourage economic development. It provides long-term financing (10 or 20 years) for fixed assets that will be used to modernize, expand, or acquire a business, including the refinancing costs related to expansion.

The loan is also known as a CDC loan because its availability is attributed to the Certified Development Companies. With SBA 504 loans, the maximum loan amount is $5 million.

These loans can cover up to 90 percent of the overall costs. Unlike conventional lender-backed loans, SBA 504 loans are backed by both the lender (50 percent) and SBA (40 percent), while you—the borrower—are expected to cover the 10 percent.

The commercial real estate loan rates of SBA 504 loans are according to the 5- and 10-year treasury rates, plus the fees. These loans often come with low-interest rates.

As of October 20, 2020, the rates were at 3.91 percent.

Down payments are also lower, as a borrower must put only 10 percent of the loan total.

That is significantly lower compared to the 25 to 30 percent down payment that other commercial loans require.

SBA 504 loans may sound great, but they have some disadvantages, such as their limited use. They may be unsuitable if you are looking for flexible funding.

You will only be able to use the loan for these approved project costs:

  • Purchasing or improving a land
  • Purchasing an existing commercial real estate property (i.e., office buildings)
  • Building a new commercial property
  • Converting, modernizing, or renovating an existing property
  • Buying long-term equipment or machinery
  • Refinancing debt is associated with development and growth as it relates to the previously listed costs.

SBA 7(a) loans

These are also popular with small business owners seeking a commercial real estate lending program to finance modernizations, construction, long-term equipment purchases, and renovations.

SBA 7(a) funds can likewise be applied to manage the costs associated with buying equipment, fixtures, and inventory, as well as for debt refinancing, start-up costs, and working capital requirements. They are more flexible than the SBA 504 loan.

The rates of SBA 7(a) loans are often lower than what conventional bank loans offer.

However, SBA limits on interest rates according to the chosen term and the size of the loan.

The loan terms range from five to 10 years, although the term loans for buying real estate come with a 25-year period.

Moreover, unlike SBA 504, SBA 7(a) is guaranteed up to 85 percent of the loan value. Loans over $150,000 are limited to a 75 percent guarantee.

The requirements for an SBA 7(a) loan are quite strict. That said, they are typically accessible to (and maybe the best choice for) small business owners who have good, robust credit.

Conventional bank loans

Many commercial lenders such as Bank of America and JP Chase offer commercial real estate mortgages to qualified borrowers.

Rates, restrictions, and requirements will vary per lender, so it is best to ask them directly.

Usually, borrowers can expect rates similar to the SBA 7(a) loan, with variable rates ranging from 5 percent to 7 percent as of October 20.

Take note that the below-average or average credit may increase the interest rate. The great thing about conventional bank loans is that they are more flexible in using the proceeds, unlike SBA loans that have a strict protocol.

Average commercial loan rates

A lot of factors can influence commercial real estate mortgage rates. They are constantly fluctuating. SBA borrowers can typically expect the qualities to be from 3.91 percent to 4.25 percent for 504 loans. For 7(a) loans, the rates can be between 7.75 percent to 10.25 percent.

Conventional bank loan rates often hover around 5 to 7 percent, but the rates can go over 7 percent as there are no limits.

Factors that affect commercial real estate mortgage rates

To understand - how are commercial loan rates determined? It’s essential to know the factors that can impact loan decisions.

Keep in mind that while every lender is different, these factors often have a hand on the rate you will receive:

  • Your credit history: Many lenders will base your ability to pay on this factor. They will look into your credit profile and your business credit score.
  • Loan type: Every loan type has its own unique average commercial loan rate. Some will have limits, while others do not.
  • Loan term and size: You can expect a higher interest rate for a longer-term. Many lenders will also consider the size of the loan to determine the rate.

Commercial real estate lenders will also consider your debt-service coverage ratio and the loan-to-value ratio.

Debt-service coverage ratio

DSCR helps lenders determine risk, specifically your capability to make monthly payments.

To determine this ratio, lenders will look at your annual net operating income to your annual loan payment, including principal and interest, also known as ‘mortgage debt service.

The net operating income is determined by subtracting the annual operating expenses from the business's annual revenue.

Lenders calculate the DSCR by dividing the NOI by the annual debt service.

Loan-to-value ratio

LTV is used by lenders to determine your risk and whether or not they will approve your loan. A lower LTV is ideal, as that signals to lenders that the loan is low-risk.

A lower LTV also often translates to lower interest rates.

The loan-to-value ratio is determined by dividing the requested loan amount by the appraised value or the property's purchase price, whichever is lower.

Commercial loan lenders typically look for an LTV between 75 percent to 80 percent for suburban properties, industrial properties, and multi-family properties.

Other costs and fees to know about

Interest rates may be crucial in determining any loan product’s affordability, but you should also consider the additional costs and fees that may impact your total costs.

Take note of standard fees like survey, appraisal, origination, loan application, and legal fees.

You should also check for a prepayment penalty, which may limit your ability to pay off a loan ahead of time.

If there is any, make sure that you understand the duration and type to make an informed decision on your repayment schedule and efforts.

Ask professionals

Check with our team at Capital Investors Direct for customized loan solutions that make sense to you.

We provide an investment-specific approach tailored to your unique needs and investment objectives, so you can acquire the right commercial real estate loan with the best rates for your specific purpose.