If you are reading this page you already know that investment in commercial real estate is one of the most lucrative, profitable and safe type of investment. This guide will show you how to obtain commercial real estate loan on most favorable terms and make your investment more profitable.
Things are very simple if you pay cash for commercial property. Calculate capitalization rate by dividing net income over purchase cost, make adjustments for capital appreciation and cost recovery, and you know how well your money will work for you. Not so simple if you want to finance part of the purchase price with commercial loan. Your commercial loan can make or break your deal. It can also double return on your investment.
Let’s use an example to illustrate how commercial loan affects your investment decision.
For the sake of simplicity we will ignore appreciation and tax benefits (including this factors does not change the conclusions and if anything it makes numbers look better).
Assume that you are purchasing an office building that generates $200,000 a year in net income for $2,000,000. If you pay cash your capitalization rate is 10% and you will get your money back in 10 years. If sell your property at this point you double your money (remember we decided to ignore appreciation) and you had 10% return on your investment for 10 years.
But what happens if you get commercial loan for 80% of the purchase price? You put down $400,000 and finance $1,600,000 with interest only 10 year fixed commercial loan.
In 10 years you will earn $880,000 ($88,000 per year after $112,000 per year mortgage payment) that will represent 22% return on investment.
Can you do better than that? Sure you can. If your property doubled in value in 10 years and you paid cash for original purchase you can sell the property for $4,000,000 and make hefty 20% a year return on your investment. But if you financed $1,600,000 with commercial loan and your property doubled in value – your return on investment will be 72% a year!
To get the commercial financing on the most favorable terms you need to understand what creates value in income producing properties. Unlike residential lending which focuses on the borrower’s ability to pay, commercial lenders concentrate primarily on the income produced by the real estate. Each type of property has it’s own income producing elements and we will examine them by major categories.