What to Expect when Applying for a Commercial Mortgage Loan:
Banks and Private Alternatives
If you have never borrowed money for your business before, you may be in for a surprise. Whether you want to
borrow working capital to expand your business or leverage equity in a commercial real estate venture, you will
soon find out the commercial loan process is very different from the more common home mortgage process.
Commercial loans, unlike the vast majority of residential mortgages, are not ultimately backed by a
governmental entity such as Fannie Mae. Consequently, most commercial lenders are risk-averse; they charge
higher interests rate than on a comparable home loan. Some lenders go a step further, scrutinizing the
borrower's business as well as the commercial property that will serve as collateral for the loan. This means
that the business borrower should have different expectations when applying for a loan against his commercial
property than he would have for a loan secured by his or her primary residence.
Following is a list of questions the borrower should ask himself and the lender before applying for
a commercial loan.
1. How am I going to meet the loan repayment terms?
Typically, bank loans require the borrower to repay his or her entire business loan much earlier than its stated
due date. Banks do this by requiring most of their loans to include a balloon repayment. This means the
borrower will pay interest and principal on his 30-year mortgage at the stated interest rate for the first few years
(generally 3, 5 or 10 years) and then repay the entire balance in one balloon payment.
Many borrowers do not save enough in such a short time frame, so they must either re-qualify for their loan or
refinance the loan at the end of the balloon term. If the business happens to have any cash-flow problems in
the years immediately preceding the balloon term, the lender may require a higher interest rate, or the
borrower may not qualify for a loan at all. If this happens, the borrower runs the risk of being turned down for
financing altogether and the property may be in jeopardy of foreclosure.
A balloon loan has other risks as well. If the borrower's business is in a "risky" industry at the time the balloon is
due (think of the oil and gas bust in the 1980s or the telecom implosion of the 2000s), the lender may back out
of all refinancing for the enterprise. Alternatively, a lender simply may decide its loan portfolio has too many
loans in a given industry, so he will deny future refinancing within that trade.
Non-bank lenders generally offer less stringent credit requirements for commercial loans. Some non-bank
lenders will make long-term commercial loans without requiring the early balloon repayment. These loans,
which may carry a slightly higher interest rate, work like a typical homeloan. They allow a steady repayment
over twenty or thirty years. It is often worth paying a one- or two-point higher interest rate for a fixed-term loan
in order to ensure the security of a long-term loan commitment.
2. How much can or should I borrow?
Most bank loans prohibit second mortgages, so the borrower should go into the loan process intending to
borrow enough to meet current business needs, or enough to sufficiently leverage real estate investments. For
a traditional acquisition loan in which the borrower is buying a new property, banks usually require a down
payment of 20-25%. So for a $600,000 acquisition, the borrower will need to come up with $120,000-$150,000
for the down payment.
Some non-traditional loans will allow the borrower to make a smaller down payment, maximizing the
loan-to-value (LTV) at 85-90%. Such loans are generally not bank loans, but are offered by direct commercial
lenders or pools of commercial investors. If the customer wants to borrow the maximum amount possible, the
interest rate on such loans may be a point or two higher than typical bank loans. Before deciding how much to
borrow, potential borrowers should:
Evaluate how much cash they are likely to need
Analyze their ability to repay the loan as it is structured
Research has consistently shown that the number one reason behind the failures of most small businesses is
the lack of adequate capital to meet cash-flow needs. Because of this it may actually be safer for a small
business to leave a larger cushion against unforeseen events by borrowing more money at the slightly higher
The amount of the loan requested has an effect on which commercial lenders will fund the loan. Small
businesses borrowing less than $2,000,000 will visit a different pool of potential lenders than those seeking
loans of over $5 million. Small business loans are generally made by direct commercial lenders (easily located
by internet searches) or by small local banks. Larger loans are generally made by regional banks, and very
large loans are made by mega-banks or Wall Street lenders.
3. How long will it take to get a commercial loan?
Borrowers generally start the loan process by contacting their bank. Unfortunately, it is difficult to secure
business loans from most banks. Besides, bank loans:
Contain the most stringent requirements
Impose the most loan covenants
Take the longest time to secure the loan.
Bank loans go through several phases of review. First, they will look at your historical income statements,
balance sheets and statements of cash flow. Then they will review 5 years of tax returns on the borrower
and all owners who will guarantee the loan.
Generally it takes several weeks before the borrower can get a verbal or written commitment letter from a
bank. Even after the loan commitment, the bank's credit committee may veto the loan. The business will
then have to start the process over with a new lender. If a firm has very good credit rating, a good
relationship with its bank, a solid and confirmable history of earnings and profits, and is not in a hurry, a
local bank will probably give them the lowest stated interest rate on the loan.
If you need to be pre-qualified quickly, you should shop for credit over the Internet or look at non-bank
sources of funds first. Once you secure a commitment from a direct lender, then you may start a parallel
process with your bank. Some direct non-bank lenders can give you a verbal commitment in a few days,
but keep in mind that you are only searching for "commercial" loans-offers from Internet companies may
often be for residential property, so you will need to screen your searches.
Keep in mind the parameters of the terms you will accept: Will you take a balloon loan? What about a
covenant or condition on the loan?
If you know that your profit and loss statements are not provable and solid, or you do not have a high
credit score, applying at banks is generally a waste of time. Instead, go directly to non-bank commercial
4. What kind of covenants and conditions are required?
Many borrowers are not aware that much more may be required than simply making regular monthly
payments on time. Many loans ask you to provide quarterly or annual income statements, balance sheets
and tax returns. Some loans will require covenants-promises that your business will meet certain tests in
the future. They may require a certain positive cash flow, or a certain debt-to-cash-flow ratio, or other
financial criteria. During a downturn in your industry or the economy, your business may face temporary
cash flow or profit shortages.
If your business falls short of the terms and conditions contained in the loan covenants, your bank may
deem that your loan has entered into default. Default triggers numerous penalties. It may require that you
pay back the loan immediately. This can cause you to have to find another lender very quickly, or face
foreclosure on the property.
Different lenders require different conditions, so ask the lender up front what conditions or covenants
apply. Some non-bank loans charge a slightly higher interest rate but will waive all covenants and
conditions except for timely repayment of the loan. If you feel that your business cash flow is uncertain, you
might want to consider these non-bank loans first.
If your business does not have its financial statements certified regularly by one of the larger CPA firms,
you may opt for a slightly higher interest rate loan. This may relax the reporting process or not require
future covenants. Likewise, if losing your business or property to the bank is likely because of the financial
test requirements, then find another lender. Ask any real estate developer who has managed to stay in the
business for 20-30 years about the risks inherent with traditional bank commercial property loans; he will
name many other developers who lost all their assets during lean times in the industry.
5. What kind of documentation will be required?
Traditional lenders require 3-5 years of financial statements, income tax returns, and other documentation.
This may include:
Original corporate documents
Personal financial records of the business owners
Keep in mind that many small businesses do not have the level of income documentation some lenders
require. If you ask ahead of time, it will save you numerous headaches from delays or rejected loan
applications. The documentation required and the timelines for approval are related-the more information
required, the slower the loan approval and funding process.
6. What if I want to sell the property?
If your business booms, you may want to repay the loan early or sell the property and move to a larger
space. Commercial mortgages, unlike residential loans, usually have pre-payment penalties. However,
some lenders will allow the purchaser of the property to assume the mortgage by taking over the seller's
payments. An assumable loan is an excellent selling point, because it provides built-in financing for the
CITI Financial Group Direct Call Today
Commercial Loans Basic
Commercial Due Diligence Overview
10 THINGS EVERY BUYER NEEDS TO CLOSE A COMMERCIAL REAL
Sellers and their agents often express the attitude that the Buyer’s
financing is the Buyer’s problem, not theirs. Perhaps, but facilitating Buyer’
s financing should certainly be of interest to Sellers. How many sale
transactions will close if the Buyer cannot get financing?
This is not to suggest that Sellers should intrude upon the relationship
between the Buyer and its lender, or become actively involved in obtaining
Buyer’s financing. It does mean, however, that the Seller should
understand what information concerning the property the Buyer will need
to produce to its lender to obtain financing, and that Seller should be
prepared to fully cooperate with the Buyer in all reasonable respects to
produce that information.
Basic Lending Criteria
Lenders actively involved in making loans secured by commercial real
estate typically have the same or similar documentation requirements.
Unless these requirements can be satisfied, the loan will not be funded. If
the loan is not funded, the sale transaction will not likely close.
For Lenders, the object, always, is to establish two basic lending criteria:
1. The ability of the borrower to repay the loan; and
2. The ability of the lender to recover the full amount of the loan,
including outstanding principal, accrued and unpaid interest, and all
reasonable costs of collection, in the event the borrower fails to repay the
In nearly every loan of every type, these two lending criteria form the basis
of the lender’s willingness to make the loan. Virtually all documentation in
the loan closing process points to satisfying these two criteria. There are
other legal requirements and regulations requiring lender compliance, but
these two basic lending criteria represent, for the lender, what the loan
closing process seeks to establish. They are also a primary focus of bank
regulators, such as the FDIC in verifying that the lender is following safe
and sound lending practices.
Great ability to repay may allow for the borrower to obtain a greater loan
to value ratio on a particular loan, or may allow a borrower to obtain a
tighter debt coverage ratio for a particular project, and may even result in
a lower interest rate on a loan because of a lower perceived risk of
default, but it will seldom result in lender accepting inadequate collateral
resulting in a loan which is even partially unsecured. This may not be
always true, but it is usually true.
Few lenders engaged in commercial real estate lending are interested in
making loans without collateral sufficient to assure repayment of the entire
loan, including outstanding principal, accrued and unpaid interest, and all
reasonable costs of collection, even where the borrower’s independent
ability to repay is substantial. As we have seen time and again, changes in
economic conditions, whether occurring from ordinary economic cycles,
changes in technology, natural disasters, divorce, death, and even
terrorist attack or war, can change the “ability” of a borrower to pay.
Prudent lending practices require adequate security for any loan of
Documenting the Loan
There is no magic to documenting a commercial real estate loan. There
are issues to resolve and documents to draft, but all can be managed
efficiently and effectively if all parties to the transaction recognize the
legitimate needs of the lender and plan the transaction and the contract
requirements with a view toward satisfying those needs within the
framework of the sale transaction.
While the credit decision to issue a loan commitment focuses primarily on
the ability of the borrower to repay the loan; the loan closing process
focuses primarily on verification and documentation of the second stated
criteria: confirmation that the collateral is sufficient to assure repayment
of the loan, including all principal, accrued and unpaid interest, late fees,
attorneys fees and other costs of collection, in the event the borrower fails
to voluntarily repay the loan.
With this in mind, most commercial real estate lenders approach
commercial real estate closings by viewing themselves as potential “back-
up buyers”. They are always testing their collateral position against the
possibility that the Buyer/Borrower will default, with the lender being forced
to foreclose and become the owner of the property. Their documentation
requirements are designed to place the lender, after foreclosure, in as
good a position as they would require at closing if they were a
sophisticated direct buyer of the property; with the expectation that the
lender may need to sell the property to a future sophisticated buyer to
recover repayment of their loan.
Top 10 Lender Deliveries
In documenting a commercial real estate loan, the parties must recognize
that virtually all commercial real estate lenders will require, among other
things, delivery of the following “property documents“:
Operating Statements for the past 3 years reflecting income and expenses
of operations, including cost and timing of scheduled capital improvements.
Certified copies of all Leases.
A Certified Rent Roll as of the date of the Purchase Contract, and again
as of a date within 2 or 3 days prior to closing.
Estoppel Certificates signed by each tenant (or, typically, tenants
representing 90% of the leased GLA in the project) dated within 15 days
prior to closing;
Subordination, Non-Disturbance and Attornment (“SNDA”) Agreements
signed by each tenant;
An ALTA lender’s title insurance policy with required endorsements,
including, among others, an ALTA 3.1 Zoning Endorsement (modified to
include parking) [or if a multi-tenant property, an ALTA 3.0 Zoning
Endorsement (modified to include parking), ALTA Endorsement No. 4
(Contiguity Endorsement insuring the mortgaged property constitutes a
single parcel with no gaps or gores), and ALTA Access Endorsement No.
17 (insuring that the mortgaged property has access to public streets and
ways for vehicular and pedestrian traffic);
Copies of all documents of record which are to remain as encumbrances
following closing, including all easements, restrictions, party-wall
agreements and other similar items;
A current Plat of Survey prepared in accordance with 2011 Minimum
Standard Detail Requirements for ALTA/ACSM Land Title Surveys
certified to the lender, Buyer and the title insurer, including items 1
through 4, 6(a), 7(a), 7(b)(1), 8 through 10(a), 11(a) and 14 from the
Surveyor's "Optional Survey Responsibilities and Specifications" referred
to as "Table A";
A satisfactory Environmental Site Evaluation Report (Phase I Audit) and, if
appropriate under the circumstances, a Phase 2 Audit, to demonstrate the
property is not burdened with any recognized environmental defect; and
A Property Condition Assessment Report [ASTM Standard 2018] to
evaluate the structural integrity of improvements and general physical
condition of the property.
To be sure, there will be other requirements and deliveries the Buyer will
be expected to satisfy as a condition to obtaining funding of the purchase
money loan, but the items listed above are virtually universal. If the parties
do not draft the purchase contract to accommodate timely delivery of
these items to lender, the chances of closing the transaction are greatly
Planning for Closing Costs
The closing process for commercial real estate transactions can be
expensive. In addition to drafting the Purchase Contract to accommodate
the documentary requirements of the Buyer’s lender, the Buyer and his
advisors need to consider and adequately plan for the high cost of
bringing a commercial real estate transaction from contract to closing.
If competent Buyer’s counsel and competent lender’s counsel work
together, each understanding what is required to be done to get the
transaction closed, the cost of closing can be kept to a minimum, though it
will undoubtedly remain substantial. It is not unusual for closing costs for a
commercial real estate transaction with even typical closing issues to run
thousands of dollars. Buyers must understand this and be prepared to
accept it as a cost of doing business.
Sophisticated Buyers understand the costs involved in documenting and
closing a commercial real estate transaction and factor them into the
overall cost of the transaction, just as they do costs such as the agreed
upon purchase price, real estate brokerage commissions, loan brokerage
fees, loan commitment fees and the like.
Closing costs can constitute significant transaction expenses and must be
factored into the Buyer’s business decision-making process in determining
whether to proceed with a commercial real estate transaction. They are
inescapable expenditures that add to Buyer’s cost of acquiring commercial
real estate. They must be taken into account to determine the “true
purchase price” to be paid by the Buyer to acquire any given project and
to accurately calculate the anticipated yield on investment.
Some closing costs may be shifted to the Seller through custom or
effective contract negotiation, but many will unavoidably fall on the Buyer.
These can easily total tens of thousands of dollars in an even moderately
sized commercial real estate transaction in the $1,000,000 to $5,000,000
Costs often overlooked, but ever-present, include title insurance with
required lender endorsements, an ALTA Survey, environmental site
assessment(s), a Site Improvements Inspection Report and, somewhat
surprisingly, Buyers attorney’s fees.
For reasons that escape me, inexperienced Buyers of commercial real
estate, and even some experienced Buyers, nearly always underestimate
attorneys fees required in any given transaction. This is not because they
are unpredictable, since the combined fees a Buyer must pay to its own
attorney and to the Lender’s attorney typically aggregate around 1% of
the Purchase Price.
This 1% figure consistently rings true, even though attorney’s fees in
commercial real estate transactions are typically billed hourly, rather than
on a percentage basis. In the hundreds of commercial real estate
transactions I have been involved in, I have found that hourly based
attorneys’ fees payable by the Buyer/Borrower at closing typically range
between .80% and 1.10% of the Purchase price, depending on complexity
of the transaction involved. For commercial real estate transactions with a
purchase price smaller than $1,000,000, the percentage is typically
higher. When the purchase price is higher than about $8,000,000, the
percentage is typically smaller. The percentage usually breaks down as
follows: Lender’s attorney’s fees (which the Borrower must typically pay)
average between .25% and .30% of the loan amount. Fees for Buyer’s
attorney usually average between .65% and .85% of the Purchase Price.
Perhaps it stems from wishful thinking associated with the customarily low
attorneys’ fees charged by attorneys handling residential real estate
closings. In reality, the level of sophistication and the amount of
specialized work required to fully investigate and document a transaction
for a Buyer of commercial real estate makes comparisons with residential
real estate transactions inappropriate. Sophisticated commercial real
estate investors understand this. Less sophisticated commercial real
estate buyers must learn how to properly budget this cost.
Concluding negotiations for the sale/purchase of a substantial commercial
real estate project is a thrilling experience but, until the transaction closes,
it is only ink on paper. To get to closing, the contract must anticipate the
documentation the Buyer will be required to deliver to its lender to obtain
purchase money financing. The Buyer must also be aware of the
substantial costs to be incurred in preparing for closing so that Buyer may
reasonably plan its cash requirements for closing. With a clear
understanding of what is required, and advanced planning to satisfy those
requirements, the likelihood of successfully closing will be greatly