Everything You Need to Know About Commercial Equity Loans
Commercial equity loans are commercial real estate loans that allow a borrower to pull equity (i.e., money) out of a commercial property. Commercial equity loans can be a great way to finance property improvements, get the funds to purchase or upgrade a different property, or invest in other assets altogether.
Commercial real estate equity loans are offered by multiple types of commercial real estate lenders, including banks, private lenders, and hard money lenders. In reality, a commercial equity loan is nearly identical to a commercial cash-out refinance, as they both involve property refinancing and allow an investor to take out funds from properties they own.
However, commercial equity financing isn’t just for real estate investors; it can also be ideal for businesses that own commercial real estate and need working capital, want to expand their business, or want to purchase real estate for business purposes.
Commercial equity loans are generally available for all commercial properties, including multifamily, retail, hotel/hospitality, industrial, self-storage, and office properties. However, higher-risk property types, such as hotels and office buildings, may have a harder time getting approved for a loan, and when approved, loans for these property types often have higher interest rates and fees.
Commercial Equity Loans vs. Commercial Equity Lines of Credit
While commercial equity loans can be great for many investors, in other situations, a commercial real estate line of credit may be a better option. While a commercial equity loan or cash-out refinance provides a one-time, lump sum amount of cash, a commercial equity line of credit (CELOC) provides borrowers a line of credit they can use as little or as much as they like during the term of the loan. CELOC terms often last 5-10 years and usually have comparable interest rates and fees to commercial equity financing or cash-out refinances.
Commercial equity lines of credit are ideal for investors or business owners who want to access funds when they need them but aren’t sure when or how much money they’ll want to use. In particular, commercial lines of credit can be a good choice for business owners who have varying working capital needs, while commercial equity loans may be a better choice for real estate investors, who are likely to know in advance how much money they’ll need to rehab or purchase a property.
Bank Commercial Equity Loans
Getting an equity loan for a commercial building from a bank can be challenging, but it’s not impossible. However, banks generally prefer only accepting borrowers with high credit scores, high net worths, and a strong history of successfully investing in similar properties.
Typical terms for bank commercial equity financing/cash-out refinancing include:
LTV: Typically 65-70% max.
DSCR: Min. 1.25x, often higher
Loan Term: Generally 5-10 years, with fixed and variable-rate options
Credit Score: Generally 720+, with some exceptions
Recourse: Most loans are recourse, with some non-recourse options potentially available for highly-qualified borrowers
Net Worth Requirement: Varies, often 100% of the total loan amount
Obtaining Equity via CMBS Cash-Out Refinancing
For many borrowers, of the best ways to take equity out of a commercial property is via a CMBS loan. CMBS loans, also known as conduit loans, generally start at $2 million and typically offer cash-out refinancing options for qualified borrowers. Unlike banks, and somewhat like hard money lenders, CMBS lenders mainly focus on the value of the property in question and less on the borrower’s credentials.
Also, unlike banks, CMBS lenders often provide loans for borrowers with lower credit scores or outstanding legal issues, as long as those issues don’t directly impact their ability to own and manage the asset in question. However, CMBS loans have a notoriously complex closing process, so they aren’t always for everyone. In addition, CMBS loans are generally not available for owner-occupied properties, so they typically aren’t a good choice for business owners.
Typical terms for CMBS loans include:
Loan Amount: $2 million+
LTV: Up to 75% (sometimes lower for riskier property types)
DSCR: Min. 1.25x (significantly higher for riskier property types, such as hotels)
Interest Rate: Highly competitive, mostly fixed-rate loans are priced around 5%
Credit Score: Generally 660+, with some exceptions
Recourse: Non-recourse with standard “bad boy” carve-outs
Net Worth Requirement: Typically starts at 25-40% of the total loan amount
Hard Money Commerical Equity Loans and Commercial Equity Loans for Bad Credit
For individuals with bad credit or pending legal issues, getting a commercial real estate equity loan can be more challenging, but it’s certainly not impossible. In these situations, borrowers must generally turn to hard money lenders or private commercial real estate lenders, who may not emphasize credit scores and focus more on the value of the underlying property.
The typical terms for hard money and private money commercial equity loans include:
LTV: Between 65-80%, possibly more with cross-collateralization (using a different property as collateral)
Interest Rates: Typically 8-15% (may be lower for investors with great credit)
Loan Terms: Typically 1-3 years
Origination Fees: Often 3-5%
Credit Score: Varies significantly by lender
Plus, if you’re looking for a fast commercial equity loan, hard money could be a great choice, as some hard money lenders can close deals in as little as 24-48 hours, with most being able to close in 2-4 weeks. This can be ideal for business owners or real estate investors who are experiencing some type of financial emergency or need funds fast to buy a new property or finance a new business opportunity.
SBA 504 Loans for Commercial Equity Refinancing
For business owners who want to refinance a current business loan or commercial real estate loan and take equity out, the SBA 504 loan program can be an ideal choice. 504 loans are intended to finance two things: owner-occupied commercial real estate and heavy equipment.
For qualified borrowers, the 504 loan program allows borrowers to take out up to 20% of the value of their appraised business assets to use toward working capital or other operating expenses. This type of commercial equity financing allows for loans up to 85% LTV.
SBA 504 loans are issued by banks and lenders, who finance 50% of the loan, and non-profit organizations called Certified Development Companies (CDCs), who cover up to 40% of the loan amount, with full backing from the U.S. SBA or Small Business Administration. SBA 504 loans are, without a doubt, the least expensive business loans available, but not everyone can qualify.
The typical qualifications and terms for SBA 504 loan include:
LTV: Up to 85% of appraised business assets
Uses:
Heavy equipment and owner-occupied commercial real estate
Generally cannot be used for working capital
Interest Rates: Low, fixed-rate financing, currently hovering around 6%
Terms: 10-25 years
Loan Limitations:
SBA 504 loans are not available for many types of businesses, including:
Banks and lending institutions
Private equity firms, real estate investment companies, investment firms, or businesses involved in speculation
Businesses involved in lobbying or political activities
Businesses that generate passive income, including those that buy and sell real estate for a profit
Casinos, strip clubs, and other “sin-based” businesses
Federally illegal businesses, like Cannabis dispensaries
In addition, borrowers must also have a feasible business plan and be able to provide personal histories for all loan principals.
Are Home Equity Loans Available For Commerical Properties?
Unfortunately, there is no such thing as a home equity loan for a commercial property. However, this does not apply to all investment properties. Since true multifamily (i.e., commercial multifamily) properties start at 5+ units, both single-family investment properties and 2-4 unit investment properties are generally able to get home equity loans from banks and private (conventional) mortgage lenders. These types of loans can be ideal for both longer-term rental property investors and fix-and-flip investors. However, it is still somewhat hard to get a home equity loan on an investment property compared to an owner-occupied home.
Typical qualification requirements for 1-4 unit residential home equity loans include:
LTV: Max. 80%
Max DTI: 40-50%
Credit Score: Min. 720
Cash Reserves: 6-15 months of payments
In addition, investment property equity loans, typically in the form of cash-out refinances, are also available from hard money and private money lenders. Like other hard money and private money loans, credit score and income requirements are much more lenient, but interest rates and fees can be much, much higher.
The Tax Implications of Commerical Property Equity Loans
Fortunately, for investors, any cash received in the form of a real estate loan (including a commercial equity loan) is typically not subject to state or federal taxes, including capital gains taxes. Despite this, in many cases, if an individual has taken equity out of property directly before or after a 1031 exchange, it may be fully taxable. For those unfamiliar, 1031 exchanges allow investors to defer paying their capital gains taxes when they sell a property by exchanging that property for another “like-kind” property within a set time period (currently 180 days).
The core issue is that all property that is exchanged must be “like kind” and cash from a commercial equity loan, so the cash is classified as a “mortgage boot” and is generally taxable. However, there is an exception; if the investor can prove that the cash they received was to achieve an important business objective (rather than just avoid paying taxes), they may allow the investor to defer (or even avoid) paying capital gains taxes on their newly acquired cash.
In one example, an investor refinanced a property about a month before finishing a 1031 exchange. When the investor was audited, they successfully challenged the audit by proving that he had tried (unsuccessfully) to get a cash-out to refinance multiple times prior to finishing the exchange and was always planning to use the funds for a legitimate business purpose.
HUD 223(f) Loans for Multifamily Cash-Out Refinances
One final way to pull equity out of a commercial property is through the HUD 223(f) loan program, though this type of loan is only available for multifamily properties and has particularly strict borrower requirements, and often takes a long time to close (sometimes 6 months or more). HUD 223(f) loans permit borrowers to take cash out, but only under certain circumstances. Specifically, 80% of the property's value must exceed all current debt in addition to all transaction and closing costs.
If borrowers qualify, they will be provided 50% of the equity proceeds when the loan closes. The other 50% is held in escrow, and will only be released after the borrower has finished any required repairs on the property, which must be inspected by a HUD-approved building inspector.
Terms for HUD 223(f) loans include:
Loan Amount: $2 million+, but most loans are significantly larger
Terms: 35 years (loans are fully amortizing)
Amortizations: 25-30 years
Max. LTV:
Market Rate Properties: 85% LTV
Affordable Housing Properties: 87% LTV
Rental Assistance Properties: 90% LTV
Min. DSCR:
Market Rate Properties: 1.20x
Affordable Housing Properties: 1.15x
Rental Assistance Properties: 1.11x
Recourse: Non-recourse with standard “bad boy” carve-outs
Prepayment Penalties: Defeasance or yield maintenance
Net Worth: Generally 100% of the total loan amount
In Conclusion: When It Comes to Commercial Equity Loans, Borrowers Have a Wide Array of Options
As we’ve discussed, taking equity out of a commercial property can be a great way to increase your overall investment returns by making value-add improvements, purchasing new assets, or funding your business. Commercial refinance lenders that allow borrowers to take cash out include banks, CMBS lenders, hard money lenders, private lenders, and, in certain scenarios, HUD multifamily lenders.
However, commercial real estate equity loans and commercial and multifamily cash-out refinances are harder to get than traditional commercial real estate loans and often come with higher interest rates and longer approval times. Therefore, it’s important to weigh and balance the interest rate, origination fees, and monthly payments on these types of loans in order to determine whether they will really provide a higher return on investment than simply retaining the equity in your property.