Making Sense of Commercial Real Estate Loan Rates

What sets the rate on a commercial property loan

Lenders price from a benchmark rate plus a spread. The spread reflects property risk, your finances, the loan-to-value ratio and the loan length.

Most commercial loans start from a benchmark such as a Treasury yield or another index, then add a margin. A stronger borrower with a stable, well-occupied property and a larger down payment gets a smaller margin.

Factors that usually matter:

• Property type. An owner-occupied building is often seen as lower risk than a speculative investment property.
• Loan-to-value. A bigger down payment lowers the lender's exposure.
• Debt service coverage. Lenders want net operating income to cover payments with room to spare.
• Borrower strength. Credit, experience and business financials.
• Market conditions. Benchmark moves flow into new quotes.

Fixed, variable and hybrid rates

Fixed rates keep payments steady. Variable rates move with an index. Hybrids fix for a period, then reset. Each shifts risk between you and the lender.

A fixed rate gives certainty, which helps budgeting. A variable rate may start lower but can rise. Many commercial loans use a hybrid: the rate is fixed for, say, the first several years, then resets to the market.

Ask what the reset formula is and whether there are caps. If your cash flow would be tight at a higher rate, a fixed structure may be worth a higher starting cost. Our overview of getting a commercial real estate loan covers the process step by step.

Fees and terms that change the real cost

Origination fees, appraisal and legal costs, balloon payments and prepayment penalties can matter as much as the rate. Compare total cost over the time you expect to hold the loan.

Two loans with the same rate can differ sharply:

• Origination and closing fees. Paid upfront.
• Amortization vs. term. A 25-year amortization with a 10-year term leaves a balloon due at the end.
• Prepayment penalties. Costly if you sell or refinance early.
• Recourse. Whether you personally guarantee the loan.

Illustrative example: on a $1,000,000 loan, a 1 percent fee is $10,000 on day one. A lender offering a slightly higher rate with no fee could cost less if you hold the loan only a few years. Run the numbers for your likely hold period.

SBA 504 and 7(a) as lower-cost routes

For owner-occupied property, SBA programs often offer long terms and lower down payments than conventional loans, though they take longer and carry program fees.

If you plan to occupy most of the building, SBA 504 and 7(a) loans are worth a look. Terms, fees and eligibility rules are set by the SBA and change, so confirm current details with the SBA or an SBA lender. Our guides to SBA 504 loans and the SBA real estate loan explain the structure.

How to compare quotes properly

Ask each lender for the same set of figures in writing, then compare the total paid over your expected holding period and the monthly payment.

1. Rate type, index and margin.
2. Loan amount, term and amortization.
3. All fees, in dollars.
4. Prepayment terms.
5. Collateral, guarantees and covenants.
6. Estimated closing timeline.

Then compute total cost over five or ten years, whichever you expect to hold. A spreadsheet with two columns is enough. A small difference in rate matters less than a large difference in fees or flexibility.

Where ROI Funder fits, and where it does not

ROI Funder does not place commercial real estate mortgages. It can help with the working capital, equipment or build-out costs around a property purchase.

For a mortgage, work with a bank, credit union or SBA lender. ROI Funder is not the right stop for that purchase. Where we can help is the money around it: moving costs, equipment, inventory, renovation work that is not part of the mortgage, or a cushion for the first months of operating in a new space.

Options include equipment financing and working capital. We consider 500+ FICO, 6+ months in business and $20,000+ monthly revenue. Applying uses a soft credit pull. See also buying commercial real estate.