Written by Elliot Smith, published in The Journal of Corporate Renewal

For business owners considering financing options for commercial real estate, the landscape can be complex. The right financing solution depends largely on the specific needs of the business, the type of property, and whether the property will be owner-occupied or used for investment purposes. Commercial real estate (CRE) lending can be broadly divided into several categories, each offering distinct advantages and challenges. The six main categories for CRE lending include banks, non-bank SBA (Small Business Administration) lenders, commercial mortgage-backed securities (CMBS), life insurance companies, hard money lenders, and private credit providers.

Each of these options has unique features—and understanding them is crucial for business owners looking to secure financing for commercial real estate. Some of these lending options are more suitable for owner-occupied properties, while others work better for investment properties. This breakdown will explore the pros and cons of each, discuss which type of borrower they are best suited for, and provide insights into how to leverage them for different business objectives.

1. Banks

Banks are the most traditional source of financing for commercial real estate. They offer a range of loan products, from standard commercial mortgages to more specialized options. The bank lending process tends to be slower than non-bank lenders, but it typically offers the most competitive interest rates and favorable terms.

Best Suited for Owner-Occupied Commercial Real Estate

Banks are often the first choice for business owners who plan to occupy most of the commercial property they are financing. This is because banks tend to offer better terms for owner-occupied properties. For example, small businesses that use the space for operations, like retail shops, restaurants, or industrial businesses, can typically qualify for more favorable interest rates, lower down payments, and longer loan terms under programs like the SBA 7(a) loan or conventional loans.

Banks also tend to favor owner-occupied properties because they are seen as lower risk. The bank's main focus is assessing the operating company’s historical profitability over the previous few years and whether the operating company can service the new proposed bank debt as well as any legacy debt that will remain. For many business owners, a bank loan will be the most cost-effective option if they have strong credit, a stable business history, and sufficient cash flow.

Pros:

• Competitive interest rates

• Long repayment terms

• Lower down payments for owner-occupied properties

• Stable, reputable lenders

Cons:

• Lengthy approval process

• Strict lending requirements

• May require collateral beyond the real estate itself

2. Non-Bank SBA Lenders

The SBA offers government-backed loan programs to help small businesses access capital for purchasing real estate. Non-bank SBA lenders are specialized institutions that focus on facilitating these SBA loans. The SBA’s 7(a) loan program is the most common option for business owners purchasing commercial real estate, particularly when the business will occupy a significant portion of the space.

Best Suited for Owner-Occupied Commercial Real Estate

Non-bank SBA lenders are ideal for businesses that may not meet the traditional lending criteria of banks but still need access to capital for owner-occupied commercial real estate. SBA loans can have more relaxed credit requirements and lower down payments (as low as 10%). This makes them an attractive choice for new businesses or businesses with limited operating history.

The SBA 7(a) loan program allows for long repayment terms (up to 25 years for real estate), and the SBA guarantees a portion of the loan, reducing the risk to the lender and making it easier for borrowers to secure funding. Non-bank SBA lenders tend to have faster approval times and more flexibility in their underwriting processes than traditional banks.

Pros:

• Low down payment (typically 10%)

• Long repayment terms

• Favorable interest rates

• Relatively flexible qualification criteria

Cons:

• Rates are typically slightly higher than bank rates

• Lengthy approval process due to SBA involvement

• Requires significant documentation

• Government fees can increase the cost

3. Commercial Mortgage-Backed Securities (CMBS)

The SBA offers government-backed loan programs to help small businesses access capital for purchasing real estate. Non-bank SBA lenders are specialized institutions that focus on facilitating these SBA loans. The SBA’s 7(a) loan program is the most common option for business owners purchasing commercial real estate, particularly when the business will occupy a significant portion of the space.

Best Suited for Investment Real Estate

CMBS loans are primarily used for investment real estate rather than owner-occupied properties. This is because CMBS loans typically require the property to generate income and are often used by real estate investors who plan to lease out the property to tenants. The income generated from the property is used to repay the loan, making these loans better suited to investment properties.

CMBS loans can be a good choice for investors looking to purchase or refinance commercial real estate for the purpose of generating rental income. They offer high loan amounts and competitive interest rates, and they can be structured with fixed or floating rates. However, they often come with stricter requirements, such as a minimum debt-service coverage ratio (DSCR) and higher underwriting standards.

Pros:

• Competitive interest rates

• High loan amounts

• Flexible terms

• Access to large pools of capital

Cons:

• Strict underwriting criteria

• Rigid pre-payment penalties

• Often require a high DSCR

• Not suited for owner-occupied properties

4. Life Insurance Companies

Life insurance companies are significant players in the commercial real estate lending space. They typically lend large amounts of capital to commercial real estate investors in exchange for a stable, long-term return on investment. Life insurance companies tend to focus on well-established, high-quality properties and can provide large, low-interest loans with long repayment terms.

Best Suited for Investment Real Estate

Life insurance companies are more interested in investment properties that will generate income through long-term leases or other stable revenue streams. Investors who are purchasing large commercial properties such as retail strip centers, mixed use, or multifamily units may find life insurance companies an attractive option. These loans often offer competitive rates and favorable terms.

Life insurance companies tend to focus on the quality of the real estate asset, including the location, tenants, and overall market conditions. While they may provide lower interest rates and flexible terms, they usually require significant documentation and may only lend to experienced investors.

Pros:

• Competitive rates

• Long-term, stable funding

• Suitable for large, high-quality properties

Cons:

• Difficult for new investors to qualify

• Focus on high-quality, income-generating properties

• Limited flexibility in underwriting

5. Hard Money Lenders

Hard money lenders are private individuals or companies that lend money based on the value of the property being financed rather than the creditworthiness of the borrower. These loans are short-term, high-interest, and typically require substantial equity or collateral to secure the loan.

Best Suited for Investment Real Estate

Hard money loans are typically used for investment real estate, especially when the investor needs to close a deal quickly or has difficulty securing traditional financing. They are commonly used for properties that need significant repairs or are otherwise considered high-risk by traditional lenders. Investors who are flipping properties, for example, often use hard money loans to finance their purchases and renovations.

While hard money loans offer fast funding, they come with higher costs and shorter repayment periods than traditional loans. This makes them a better option for investors with a clear exit strategy, such as selling or refinancing the property within a year or two.

Pros:

• Fast funding

• Flexible terms

• No strict credit requirements

• Ideal for high-risk or distressed properties

Cons:

• High interest rates

• Short-term loans

• Requires substantial collateral

• Expensive fees

6. Private Credit

Private credit refers to non-bank lenders, such as hedge funds, levered/un-levered funds, and other institutional investors, that provide loans directly to businesses or real estate investors. These lenders offer greater flexibility than traditional banks, with terms and rates that can vary widely based on the borrower’s needs and the risk associated with the investment.

Best Suited for Owner-Occupied Commercial Real Estate

Private credit lenders can be an attractive option for business owners who need more flexible terms or quicker access to capital for owner-occupied commercial real estate. Unlike traditional banks or SBA lenders, private credit providers may be more willing to consider the unique financial situation of the borrower and the specific needs of the business, making it a good option for business owners with less conventional financing needs.

Private credit can also be useful for businesses that may not qualify for traditional loans due to credit challenges or other factors but still require capital for real estate purchases. The flexibility and speed at which private credit lenders can approve and fund loans often make them a better choice for business owners who need to act quickly or have unique situations that don’t fit the rigid criteria of banks.

Pros:

• Flexible terms

• Quick approval and funding

• Tailored loans for owner-occupied properties

• Higher risk tolerance

Cons:

• Higher interest rates

• Shorter loan terms

Conclusion

When deciding between these various commercial real estate lending options, it's important to understand which types of properties each option is best suited for. Banks, non-bank SBA lenders, and private credit are generally more suitable for owner-occupied commercial real estate because they tend to offer lower interest rates, longer repayment terms, and more flexible qualification criteria for business owners who will occupy the property. These options are designed to support the business's growth while minimizing the financial burden on the owner.

On the other hand, commercial mortgage-backed securities, life insurance companies, and hard money lenders are better suited for investment real estate. These lenders typically provide large loans for income-producing properties and are more focused on the income-generating potential of the property rather than the borrower’s business operations. CMBS and life insurance companies offer competitive rates and long-term financing for high-quality properties, while hard money lenders and private credit can be used for riskier investments or situations requiring fast funding.

Understanding these distinctions allows business owners and real estate investors to make informed decisions about which financing option is the best fit for their needs. By choosing the right lender, businesses can secure the capital they need to succeed while managing their risk and financial obligations effectively.