Florida’s rental real estate market is hot, and for many investors, there’s never been a better time to buy. However, securing the financing you need to get a great property in Florida’s real estate market can be tricky, especially if you plan to rent the property out for a profit.
Today, let’s take a look at how to use commercial loans to buy residential rental properties in Florida and why you might consider doing so instead of pursuing other financing methods.
What Are Commercial Loans?
Commercial loans are a type of loan between a borrower and a bank or financing institution, just like conventional mortgages. However, unlike conventional loans, commercial loans must be taken out for commercial/investment purposes (i.e., to make money).
In Florida, you cannot take out a commercial loan to buy a rental property if you plan to live in that property yourself. Instead, you’ll have to find other financing options like an FHA loan from the Federal Housing Administration.
If you’re taking out a commercial loan to make money on a residential rental property, private lenders may be a great option. Private lenders set their own requirements and are much more streamlined compared to a traditional bank or mortgage lender. Most private commercial lenders do not require income documentation and can close your loan in less than a month.
What Credit Score Is Needed for a Commercial Loan?
Commercial loans for the purchase of an investment property are typically not credit score driven. This makes a commercial loan a great option for foreign nationals, especially if they have not established credit history in the U.S.
However, keep in mind that a lender may still need to pull your credit to ensure there is no history of major delinquencies, such as a recent bankruptcy or foreclosure.
What Down Payment Is Needed for a Commercial Loan?
From the lender’s perspective, financing an investment property is considered higher risk than financing a primary residence. If the borrower runs into financial trouble, they will prioritize the mortgage on their primary home over their investment property. As a result, commercial lenders will require a higher down payment, typically between 35 - 50 percent.
Similar to a traditional loan, applying for a commercial loan with a higher down payment, may give you access to better rates and terms, which can lower your closing costs and/or monthly mortgage payment.
Commercial Real Estate Loans vs. Conventional Home Loans
Although mortgage lenders may provide financing for both commercial and residential real estate, there are several important differences between commercial real estate loans and conventional home loans that you’ll want to understand.
For starters, commercial real estate loans differ in some significant ways, including:
Interest rates.Interest rates for loans for investment properties are typically higher than primary residence loans.
Loan-to-value. LTV ratios measure the size of the loan to the value of the property (collateral). Most commercial lenders will have lower LTV limits, and therefore require a higher down payment.
Repayment period. Most commercial loans are short term loans ranging from 1-5 years. These loans are often interest-only loans, which means the borrower's monthly mortgage payment only covers the interest, with the principal amount due at the end of the loan term.
Exit strategy. Since commercial loans often have shorter repayment periods, your lender will want to make sure you have an exit strategy in place to cover the lump sum due at the end of your loan term. Common exit strategies include:
Refinance the loan
Sale of the property
Repayment from other source
Individual Borrowers vs. Corporate Entities
Most commercial lenders will require you to finance the property under an LLC or Corporation. Requirements on how the LLC or Corp needs to be structured varies by lender. At Vaster, we require the borrower to create a single purpose entity that is authorized to do business in the subject property state.
A Single Purpose Entity (SPE)is a legal entity created to satisfy an investor’s specific investment purpose. In the context of real estate transactions, an SPE is created to own and operate a particular piece of property.
The main characteristic of an SPE is that it holds the title to the real estate and operates no other assets. The two most commonly used corporate structures for SPEs are either a Limited Liability Company or (LLC) and Corporation.
Debt-Service Coverage Ratios
During the underwriting process for an investment property, commercial lenders also take a hard look at an asset’s debt service coverage ratio, or DSCR. In a nutshell, these describe how much cash flow is generated by the property and available to pay for its associate debt obligations.
In some scenarios, lenders might look at an individual borrower’s DSCR, rather than an asset-based DSCR. The bank may look at your DSCR and discover that your cash flow is too volatile or risky for their comfort.
This is why it’s oftentimes easier to secure commercial loan financing if you have excellent cash flow but no other outstanding debts or loans under your name at the time of application. At Vaster, we run credit reports that show the guarantor’s debt obligations; however, we underwrite loans solely based on the property’s cash flow.
However, there are many loan products that primarily consider asset-based DSCRs, that is whether an investment property brings in enough income to pay off the mortgage an individual takes out on the property.
Who Can Take Out Commercial Real Estate Loans?
There's one other aspect to using a commercial loan to buy a rental property in Florida: you cannot plan to live in a property as either your primary residence or secondary home. In fact, you can take out a commercial property loan for an investment property if and only if you plan to rent it out or develop it separately.
When Does a Commercial Loan Make Sense?
A commercial loan could make a great deal of sense for your financial situation depending on circumstances, your preferences, and other factors.
You’re Experiencing a Gap in Liquidity
For example, if you have a gap in your liquidity — that is, your available cash for real estate investing or opening up new business ventures — a commercial loan could help you get the funding you need to push a deal through or expand your portfolio.
This is particularly advantageous if you know that a rental property will start turning a profit in the short term (in, for example, less than a year post-closing the deal). This can effectively increase your cash flow over time in exchange for a short-term loan deal.
You’re a Foreign National
If a foreign national, you may be barred from other forms of financing if you try to build up a real estate portfolio. This is to protect the real estate market from foreign interests and large corporations that would make it difficult for Americans to buy or rent properties.
A traditional commercial loan from a trusted American financing institution could be a good way to get the property you want, even with your foreign national status. Even if you don’t have a credit history or other traditional signs of creditworthiness, a commercial business loan could be what you need to get your project going.
You’re Facing a Contractual Obligation
Alternatively, maybe you are facing contractual obligations that require a fast closing, but you don't have the funds to make the deal go through quite yet. If you fail to uphold your end of the contract, you could risk losing your deposits.
You can instead use a commercial loan to complete your transaction. Then you can pivot to other forms of financing later (potentially with better interest rates or other loan terms) if needed.
You Need a Short-Term Solution While You’re in the Process of Qualifying for Long-Term Financing
Commercial loans can also be a financial Band-Aid if you are in the process of qualifying for long-term financing. In brief, you can take out a commercial loan to cover you for three months to six months or more until your long-term financing agreement goes through. This is what lenders call a bridge loan, quite literally bridging a gap in financing or time before permanent senior financing becomes available.
Or, you can refinance your current outstanding mortgage and replace it with more favorable terms and conditions, depending on market factors. Remember that some commercial loans for real estate do come with prepayment fees that make refinancing tricky. These fees could result in you paying more than you anticipate if you try to pay off your loan earlier than expected.
You’re Purchasing a Property That’s Not Fannie Mae Approved
Some rental real estate properties are not Fannie Mae approved, meaning that traditional forms of rental property financing may not be available to you.
Condotels are great examples. These are essentially condominiums that have been renovated or set up as hotels with services like room cleaning and registration desks. Many condotel units are owned by individuals, although those owners can place their units in the rental program and rent them out for a small profit.
Because condotels are hybrid buildings, they are not approved by Fannie Mae, so you may need to get a commercial loan to cover your costs instead.
How To Find the Right Financing for Your Florida Rental Property
It’s important to look through the exact terms and details of any commercial loan before signing on the proverbial dotted line. You’ll need to consider several factors, including:
Origination fees (lender points, due diligence deposits)
The term length (i.e., how long you’ll spend paying back the loan)
Vaster’s Lending Options
Fortunately, Vaster has a wide range of excellent lending opportunities available for investors just like you. We offer commercial loan instruments for:
Residential properties like single family homes and condos
Multifamily properties like duplexes and apartment buildings
All in all, commercial loans are valuable financial tools you should consider using when you need to close a deal, cover a contractual obligation, or simply pick up a great property you plan to renovate and rent for a profit. Commercial loans can cover a lot of financial gaps in your portfolio.
Even better, commercial lenders like Vaster make getting the financing you need easier than ever. We close loans faster than the competition (as quick as two weeks). What began as a joint venture between the Fortune International Group and The Related Group has grown into one of the premier residential and commercial real estate lenders in the Miami area.
Contact one of our loan officers today to see how we can help you get the financing you need.