Commercial real estate loans help you buy, build, and renovate income-producing properties. To approve this loan, a lender will look at your business’s income or (sometimes) the potential in your idea.
A few costs you pay to secure a commercial real estate (CRE) loan include:
- The down payment (it is mostly 20-35% of the property’s value)
- A monthly interest (the cost of borrowing the money).
- The actual chunk of the loan paid back each month (called the principal amount).
Since these are the inevitable costs, some think these are the only ones worth tracking. However, commercial real estate loans come with a few hidden charges that, if not accounted for, can impact your balance sheets.
That’s why today we’re talking about costs that some CRE loan borrowers tend to overlook. Keep reading!
Costs in Commercial Real Estate Loans Owners May Overlook
According to a Deloitte report, increasing interest rates and cost of capital are among the top concerns in CRE debt markets. These giant hurdles aside, you should also watch out for the following silent costs as they pile up fast:
Prepayment Penalties
If you decide to pay off your commercial loan earlier than the agreed-upon date, you’ll pay a fee. This prepayment penalty exists because lenders count on earning a certain amount of interest over the full term. So if you opt out of the agreement earlier than decided, this penalty is the compensation for the interest income they lose.
For most commercial loans, the effective penalty can be 2–5% of the outstanding loan balance early in the term. And then, it typically decreases as the loan gets closer to its maturity date. For instance, if you have a $5 million loan and the penalty is 3%, the fee can be $150,000.
Rate Lock or Extension Fees
We can loosely define the rate lock as an insurance policy you buy from your lender. It guarantees that your agreed-upon interest rate won’t increase between the time you get your loan commitment and the closing date.
Notably, some lenders offer a standard 30-to-60-day lock for free, during which you don’t pay a higher interest. But if you want a longer lock period or wish to extend the expiring lock, it’ll come with an attached cost. This fee is non-refundable and costs you 0.25% to 0.50% of the loan amount.
These fees are one-time expenses that increase your immediate out-of-pocket costs. However, they do not directly affect your future monthly payments; they just ensure your loan closes on time at the commercial real estate loan rates you budgeted for.
Environmental Report Fees
This is an upfront fee that covers the cost of hiring an expert to inspect your property for potential toxic issues, such as soil or groundwater contamination.
In most CRE loans, the initial check is called a Phase I report. At this point, the expert looks at records and inspects the site, costing $1,500-$5,000+. If the real estate in question is a complex industrial site, the fee will run much higher.
Note that you, as the borrower/owner, only face this fee if the report finds a problem, because then, you’ll need an expensive Phase II report to do more soil/water sampling. If contamination in your property is confirmed, the real hidden cost on your loan will show as the massive cleanup charges or the potential for a lower property value.
Reserve Requirements
A reserve requirement means you set aside cash as funds for future major expenses or if you face a business loss. This mostly hidden cost is often based on the property size, like $0.10 to $0.35 per square foot per year, or a set amount per unit.
For taxes and insurance, the initial amount is fixed to cover a short-term cushion (usually two months). But over the loan’s life, these funds can reduce the money you can use for other business needs, so understanding them is important.
Inspection Fees
You pay an inspection fee when the lender needs to check the collateral; it’s like a service charge paid to an inspector or appraiser. These costs depend on your property’s specifications, but in most cases, it’s a flat fee of $1500 and up.
Over time, this cost appears whenever the lender wants to verify the property’s condition. Suppose you have a 10-year loan and the lender requires four inspections. That’s four separate fees added to your operating costs, so being unaware of these will hurt your finances.
Conclusion
Every commercial real estate investment is a massive opportunity, but you don’t realize its full implications without seeing the whole financial picture. Now that we have discussed some hidden costs that come with these loans, you can budget smarter.
If you don’t want surprise charges to chip away at your profit, explore commercial real estate loans at ROK Financial. We’re a partner who values transparency as much as you do during your investment journey.
Ready to finance your commercial win with confidence? Let’s talk!
FAQs
What is a balloon payment?
A balloon payment is a large lump sum you must pay at the end of a commercial loan’s term. Since your monthly payments only cover a small part of the principal, the final payment is hefty and covers the remaining debt.
Why is the timeline of a commercial real estate loan shorter than that of a home loan?
Commercial loans are shorter (5-10 years) because they allow the lender to re-evaluate the property’s value and the interest rates more frequently. These aspects protect the lender from long-term market changes.
Do I have to personally guarantee a commercial real estate loan?
Yes, a personal guarantee is required for most small-to-mid-sized commercial loans. It means that if your business defaults, the lender can go after your personal assets.
