Types of Financing for Commercial Real Estate Development

​Commercial real estate lending refers to lines of credit to finance business-owned property in various forms of commercial activity. Borrowers include owners of industrial warehouses, real property like malls, and office blocks. The substantial funds required to build, renovate, and remodel commercial buildings often require financing from lenders like banks, private investors, large credit unions, and entities with substantial finances like insurance companies and pension funds. Thus, real commercial estate loans include owner-occupied mortgages, income-producing commercial mortgages, construction loans, and bridge loans.

Owner-occupied mortgages target property owned and occupied by the same business. The business must occupy at least 30 to 50 percent of the property. The mortgage payments emanate from the business's operating cash flow. In most cases, lenders undertake thorough research to establish whether the company's financial status is enough to serve the mortgage. Lenders use the 5C models to determine the company's creditworthiness by measuring the character, capacity, capital, collateral, and condition.

In addition, lenders, especially banks, evaluate the debt service coverage ratio to determine if the borrower's cash flow is sufficient for the loan's annual interest and principal amounts. The condition comprises the primary purpose of the borrowed fund. Compared to other commercial real estate loans, the maturity loans are relatively long and, on a reducing balance, can range between 15 and 25 years.

The second commercial loan is the income-producing commercial mortgage, which enables the property owner to purchase, refinance, renovate, or remodel the property. The cash flow to service the loan depends on the nature of the business and can range from sales to tenants' rental payments for retail property. In this aspect, the lender evaluates the nature and frequency of the cash flow, such as sales flow and the lease on the property. Also, the nature of the company determines the loan period to minimize the risk of default due to business change. For example, generic administrative offices would attract a longer duration than non-volatile companies like specialized factories.

Sometimes, developers and real estate investors come across viable projects but lack the funds for purchase. Construction loans are available for development from the ground or redevelopment of physical structures. Compared to other real estate commercial loans, it poses a high risk and unpredictability to the lender due to limited cash flow. To mitigate the two concerns, lenders typically offer the loan in stages as construction progresses on pre-agreed stages or time. However, the lender remits interest rather than cash payments. Upon development completion, the borrower repays the total amount disbursed in the project stages, plus interest.

Property developers use these loans because they can repay them using the proceeds from the property. However, other parties can still access this loan by using funds from the primary loan, such as the income-producing mortgages, to clear the construction loan.

Lastly, the bridge loan cushions the property owner from the repercussions of default by funding the deficiency. The short-term loan enables the borrower to meet repayment obligations, like servicing an income-mortgage loan during the low-tenancy season to avoid foreclosure. The characteristics include high interest rates and collateral like inventory.

There are four types of bridging loans. The first, the closed bridging loan, includes a predetermined repayment period for serving certainty upon maturity. An open bridged loan lacks a predetermined repayment date. The uncertainty means the lender deducts the interest from the loan advance and imposes higher interest rates than the closed bridge option.

In cases of a high risk of default on the bridge loan, lenders typically employ the first chance option, which means that when the finances stabilize, the funds, such as cash flows, service the bridge loan before other lenders. Another option is the second charge, which differs from the first only in that the borrower services the bridge loan after paying the other lenders.

Ronald David Paul

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