Financing Requirements for Owner-Occupied Commercial Real Estate

You’re looking to purchase property or expanding the existing location where your business operates. Or your existing business has outgrown its current location and needs a bigger space. Regardless of the situation, when financing your commercial property, you will likely apply for an owner-occupied commercial real estate loan.

How to Qualify

Financing commercial real estate is a multi-step process that involves the lender evaluating five primary factors to determine the level of risk that comes with approving the loan. For an owner-occupied commercial loan, a business must occupy more than 50% of the facility on the property to be classified as Owner Occupied.

The Five C’s of Credit: What Lenders Are Looking For

The five factors that lenders consider when approving a commercial real estate loan are: capacity, character, collateral, capital, and environmental conditions.

• Capacity – The bank considers a business’ capacity when deciding whether to approve a loan. Capacity examines a borrower’s ability to repay a loan based on the applicant’s available cash flow. When evaluating this element of credit, lenders consider whether the borrower can cover new loan payments on top of their existing debt service.
• Character – This refers to credit history and trustworthiness. Lenders will review the credit history of the business to determine its overall financial performance over the past few years. Credit history indicates the financial health of the business and whether a commercial property loan would be a good investment for the lender. The lender wants to know that the borrower and guarantors are reliable and have the ability to support the debt.
• Collateral – An owner-occupied commercial real estate loan requires the borrower to pledge the property as collateral which balances the amount of risk for the lender. The property being financed by the loan can serve as a collateral asset. The collateral must be evaluated to ensure that an adequate value exists and that the collateral is marketable in the unlikely event that a collection action should occur.
• Capital – A business that is interested in a commercial property loan will be required to provide financials and any other debt information. This will help to determine the resources a business has to cover their potential loan and any unforeseen changes that may occur.
• Conditions – Banks and lenders take environmental factors into consideration when approving loans. In order to determine if a loan is a good investment, the bank will look at the industry and climate that the business is in. Is the industry experiencing growth? Has the industry been negatively impacted by a global event? Do industry trends predict any future risks that could hinder the borrower’s ability to pay back the loan? While they are out of your control, these macro-economic factors can affect whether or not your loan is approved.

These five main factors—capacity, character, collateral, capital, and environmental conditions—are all included in a lender’s credit evaluation for a commercial loan for a business. Lenders use this information to gauge the level of risk that comes with a commercial loan. If a business does qualify for a loan, this evaluation also helps lenders determine the terms of the loan.

Improve Your Chances of Getting Approved

If you know the factors that lenders consider, you can increase your likelihood of being approved for a commercial real estate loan.

• Accurate Records – It is important to have accurate and detailed financial documents when applying for a loan. Be prepared to present documents such as bank statements, tax returns, financial statements, etc. If you have had your business for several years, your financial records should include the past two to three years.
• Good Market Conditions – Although you cannot control environmental factors surrounding your business, being informed about market conditions and trends will help you understand what lenders will consider when considering your loan. This knowledge might even help you determine when to apply for a loan. Good market conditions can mean a higher chance of getting your loan approved.
• Manageable Debt – Lenders will underwrite the underlying cash flow of the operating business to assist in determining the final loan amount as well as to evaluate the borrower’s ability to repay the debt.
• Sufficient Collateral – The property you are financing will serve as collateral for the loan. Therefore, the approval process includes obtaining an appraisal on the property. Once the appraisal has been received and reviewed, the bank will determine the final loan amount by applying applicable advance rates to the lessor of the property’s cost or appraised value. You should perform diligent research on the property as its value indicators (age, location, maintenance-level, environmental conditions, etc.) are also strongly considered in the approval process.
• Good Personal Finance – Lenders don’t just look into the financials of your business; they will look into the personal finances of the owner as well. In the event of the loan defaulting, the responsibility of paying the debt will fall to the guarantor, usually the owner of the business. A guarantor with good personal finances will make lenders more confident in approving a loan.

Alternative Lending Options

Unconventional financing options are available to business owners through banks or alternative sources if the business owner is not able to meet the credit requirements for conventional bank financing. The Small Business Administration’s (SBA) 7(a) and 504 loan programs are two such financing options that provide advantageous terms for the small business owner as well as credit enhancements for the lender which increase the likelihood of loan approval.

If a bank is not comfortable with the risk on a loan, and the SBA alternative is not an option, the lender will often refer the borrower to other funding sources. These alternative sources are not traditional banks and are likely more risk tolerant.

How to Start

If you’d like to learn more or are interested in applying for an owner-occupied commercial property loan, contact a PlainsCapital Bank representative at 866.762.8392 or learn more at PlainsCapital.com. Our lenders will be able to provide you with more information on the process of applying for the right loan to meet your business’ needs.