hen it comes to commercial real estate financing, there’s no denying that long-term debt is the standard. There is good reason for this. The high value of CRE property, and its typical increase in value over time, makes it excellent collateral. What’s more, CRE investors typically expect to see long-term returns on their property, making loans that span years more feasible and attractive.
The benefits don’t end there. While many can be tempted by the low interest rates of short-term loans, they often come at a cost.
Long-Term Debt and Short-Term Debt: An Overview
In commercial real estate, long-term debt refers to lending that will be repaid in more than ten years. Anything scheduled to be paid in under ten years is considered a short-term debt. Three-, five-, and seven-year loans are not unheard of in CRE. They are all, however, short-term loans, and require careful consideration.
Long-term debt is very common in commercial real estate. Just as many homeowners are familiar with the concept of a 30-year mortgage, so are CRE investors familiar with loans that span decades. Real estate investment, after all, is long-term by nature.
Long-Term Debt Offers More Predictability
Long-term and short-term CRE debts are treated differently. Short-term loans, for example, are typically provided by commercial banks. The Federal Reserve (the Fed) sets policies which affect commercial banks and their loans. They are also affected by their deposits, overhead, portfolio, and discount rates. These multiple, shifting factors create competition among banks as loan providers.
Short-term loans typically don’t have fixed rates, because they are based on short-term market rates that often change. This also means that any changes affecting a borrower’s bank can translate to increased rates.
Things look a little different for long-term loans. These lenders look at the bond market rather than the Fed. In commercial real estate, this typically means using the treasury as a benchmark. Because secured bonds are low-risk, long-term commercial real estate loans are often issued with the advantage of a fixed rate.
Having predictable, fixed rates gives long-term debt an advantage over short-term.
Long-Term Debt Creates Better Cashflow
One of the benefits of short-term debt is low interest rates. However, the savings provided can erode over time. Closing costs and fees associated with refinancing sometimes leave short-term borrowers in a bind. Committing to a long-term debt plan up front often avoids these costs.
Even more important, and possibly the biggest benefit of long-term debt, is low monthly payments. Because of the length of time allotted to pay back a loan, cashflow becomes more available and predictable with long-term debt.
Lenders and borrowers alike appreciate reduced risk. While long-term borrowers enjoy a set monthly cost and fixed rate, lenders will expect information up front that demonstrates an investment’s security. Lenders want to know that over the course of the loan term, something won’t go wrong to cause a borrower to default.
To this end, loan providers determine eligibility with a variety of factors. Every lender has their own eligibility requirements, and some types of lenders are known for being more stringent or relaxed. Long-term borrowers should expect to discuss information such as:
- Down payment amount
- Real estate value
- Size of loan
- Repayment structure
- Credit scores
- Business credentials
Types of Long-Term Loans
Short-term debt isn’t wrong for all borrowers. For short-term cashflow problems, it may be a fitting solution. Major equipment or property investments, however, are better done with long-term debt plans like the ones below. These can be paid off with income from business operations over the course of the term length.
Traditional bank loans: Banks have provided commercial real estate financing longer than any other entity. If a borrower has a strong relationship with their bank, it’s still possible to go to them for a long-term loan. A large down payment will be helpful. Banks looking to reduce risk, however, may suggest an SBA loan to some borrowers.
SBA loans: The Small Business Association (SBA) offers two kinds of commercial real estate loans. For both, a portion of the loan is guaranteed by the government. With a 504 SBA loan, a bank loans 50% of the purchase price, and the government 40%, leaving 10% to the borrower. The 7(a) SBA loan also requires a 10% down payment; the government covers the other 90%.
SBA loans have low fixed interest rates, and can be used for property repairs, as well as purchasing and upgrading real estate and business equipment. While highly desirable, qualifying is tough. There is, however, another option.
Commercial lenders: Lenders such as Pioneer Realty Capital offer flexible underwriting, fast approval, and lower fees and closing costs for long-term debt. Using many sources of capital and an extensive network of partners, they also allow borrowers to find a financing solution that meets their unique needs. In addition to CMBS loans, bond financing, insurance company loans, and other options, Pioneer Realty Capital is also entering the crowdfunding CRE investing space.