Commercial vs. Residential Lending

In an effort to diversify their portfolio, many residential mortgage originators are eyeing the commercial real estate market. However, many originators are new to the commercial market and do not know how to penetrate it or what to expect. Many do not understand the qualities of a good commercial estate deal and the available lending options. If you want to plunge into the commercial real estate market, you need more than your experience in the residential real estate market. You need to diversify your knowledge and your tactics to successfully grow a pipeline from residential to commercial. Some of the key factors that you have to understand between the residential and commercial real estate markets are:

Difference between Residential and Commercial Properties

The first step entails learning the key differences between residential and commercial properties.  Any property used for commercial or business purposes qualifies as commercial property. For tax purposes, a residential property may qualify as a business property if it has several distinct or specified units. Residential properties in the same neighborhood tend to look similar, but this is not the case with commercial properties. Despite being in the same neighborhood, commercial properties often appear unique and serve distinct purposes.  

Unlike residential properties that often have a lot in common, commercial properties have little in common, yet they fall under the common umbrella of commercial real estate. Commercial real estate comprises properties like apartments, retail, offices, and warehouses.

To best understand the commercial real estate market, you should start with your local property market. Consider different commercial properties, identifying the more prevalent properties. Identify the ones that you can close on easily and the ones that might be challenging to close.

Residential vs. Commercial Loans Processing Times

Loan processing procedures for commercial loans tend to be longer and more complicated than residential loan processing procedures.  Most conventional lenders take several months to close commercial loans, but the process might be shorter with non-bank alternative lenders.

Which Income Matters

For residential properties, lenders mainly consider the applicant’s income, including their gross income and debt. Many lenders prefer a borrower’s debt to be no more than 45% of their gross income. The residential loan payment should not be more than 28% of the borrower’s gross income.

However, when evaluating a commercial property loan, lenders consider the property’s ability to generate income. In other words, residential lenders qualify the borrower while commercial lenders qualify the property. Although some commercial lenders qualify the borrower, most of them spend time considering the property’s ability to generate revenue.  

Lenders calculate a property’s debt service coverage ratio, commonly abbreviated as DSCR. To get a property’s DSCR, lenders take the property’s NOI (net operating income) and divide it by its debt service (the principal and the interest amounts). Property should produce sufficient or ample revenue to satisfy the loan repayment.

If a property has a DSCR of 1:1, it means that the property only earns what it owes. Most lenders prefer properties that have a DSCR of 1:1.25 and above. This way, lenders are sure that the property will generate enough income to repay the loan and still have some disposable income.

Length of Payment

Conventional residential property loans have a repayment term of up to 30 years. Some residential homes are negotiable into even longer repayment periods because lenders consider residential mortgages low-risk loan products. Due to the increased risk in commercial mortgages, commercial loans have shorter repayment periods ranging from 5 to 10 years. Therefore, commercial borrower’s mortgages have frequent refinancing. While some commercial borrowers enjoy the flexibility of short-term borrowing, others are more inclined towards long-term loans with fixed interest rates.  

Down Payments

Residential mortgages often have negotiable down payments. If a borrower has good credit, it is easy to get a zero-down residential mortgage in a strong housing market. However, commercial mortgages are considered riskier than residential mortgages. Therefore, most lenders will demand a down payment typically, 20% and 80% loan-to-value ratio. However, a 10% down payment on commercial property is possible in a well-established business environment with many lenders competing for commercial loans.

If you’re just getting into commercial lending, you should give yourself enough time to familiarize yourself with the commercial lending process before seeking commercial business opportunities. You may need additional documentation, different from documentation needed for residential approval. After gaining enough knowledge in commercial lending, you’ll be in a better position to pass this knowledge to prospective loan applicants. You’ll help the borrowers to understand how commercial lenders review and qualify commercial loan requests.

If you give your clients the best lending experience, they’ll probably come back to you for refinancing. Your focus should be to create a strong relationship with your clients. Commercial lending has vast opportunities for repeat business. These opportunities don’t exist in residential lending.

If you are looking for real estate loans, ABO Capital can take care of all of your needs. Whether you are looking for a commercial real estate loan, or a residential real estate loan, we will take care of it for you. If you are ready to apply, you can fill out the application and we will be in touch soon.