Sell for More Trivia is a weekly blog series that playfully presents a trivia question about commercial real estate.
We’re now in the longest economic boom in our country’s history…and borrowers have choices. Namely, to borrow from a traditional bank or from a private lender. It’s important to understand each.
Bank lending is the most traditional and the most common financing source for commercial real estate. In fact, it’s been reported that in 2018 commercial and multifamily mortgage originations by banks grew 14%.
Why? Many buyers, especially those new to the business, believe the bank is the only place to get a business or commercial real estate loan.
Others think banks are more trustworthy than alternative lender options. And some believe their standardized process is superior.
Traditional banks do have obvious competitive advantages. For example, bank loans typically offer lower interest rates.
Note: This is because depositors keep steady cash in their checking and savings accounts so banks have easy access to these funds for lending purposes. And banks don’t pay much for the use of those funds. In fact, most pay under half a percent today, making for very cheap funding for loans. Additionally, all banks have access to federal funds with current rates at just 2.5%.
But the process of getting this type of financing is much more difficult. For one, banks have stricter loan regulations and often don’t lend to new business owners. They also have strict requirements regarding credit history, overall cash flow, and debt-to-income ratios, sometimes turning down experienced developers and owners with solid business plans.
Lastly, the loan approval process may be more drawn out.
On the other hand, private loans have grown to become a popular alternative to traditional bank loans. Especially for borrowers looking for bridge or construction financing.
It’s no secret that private loans tend to have higher interest rates.
Note: This is because private lenders must repay the investors or lending bank for the funds they loan out. Those funding sources charge a higher interest rate then the federal government charges banks.
On the plus side, private lenders often offer flexible payment plans and may require less of a down payment.
Getting a private loan can also be a faster, more streamlined process than a bank loan. For example, there aren’t strict parameters for lending, which gives both the lender and the borrower flexibility. This increases the borrower’s chances of approval, as private lenders are more willing to work on a case-by-case basis and rely on their intuition, putting less emphasis on blemishes in credit history, net worth, and liquidity.
Additionally, with private lending, borrowers are usually in direct contact with the decision makers that are responsible for making funding decisions— as opposed to bank loans which must go through multiple tiers of approval.
Furthermore, more private lenders offer non-recourse loans, which allows borrowers to use the underlying property as collateral in a deal instead of personal assets.
You must realize, however, that most private loans are designed for short-term purposes only. This means borrowers must show their project’s potential income and create a realistic exit strategy upfront. Also, borrowers may need to cross-collateralize.
Whichever path you choose, it’s important to know your options and do your homework. At minimum it’s nice to have private lenders around to make the loans that banks can’t, or won’t, make.
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About Beau Beach, CCIM
Beau is a tenacious Commercial Real Estate Broker, author and adoring father of four. His clients appreciate his no-nonsense demeanor and his legendary work ethic.
Beau leads Beachwood which is a commercial real estate broker for sellers in the Nashville, Milwaukee, South Florida and Chicago markets.
He’s the author of the books The 3 Reasons: Why Most Commercial Properties Don’t Sell and True Wealth: What Every Seller Should Know About 1031 Exchanges.
Beau can be reached at 800-721-3287, click to schedule a call or Beau@ProwessIRES.com