Commercial Lending Guide: Types, Terms, and What Borrowers Must Watch For
Commercial real estate lending is not one market. It's multiple markets with different players, different underwriting standards, different regulatory environments, and different risk profiles operating under the same general label. Navigating it well requires understanding the distinctions, not just the broad categories.
Coventry Enterprises has compiled this guide to give commercial real estate borrowers the foundational knowledge they need. This builds on the comprehensive commercial real estate financing guide and focuses specifically on the elements of commercial lending that create the most opportunity for problems.
Commercial Loan Types: A Detailed Overview
Permanent Commercial Mortgages
Permanent loans are the long-term debt structures for income-producing properties with stable, established cash flows. They're appropriate when a property is fully or substantially stabilized, generating reliable income, and ready for institutional underwriting. Term lengths typically range from 5 to 30 years with amortization periods often extending beyond the loan term, creating balloon payments.
The primary risk in permanent commercial loans is refinancing at balloon maturity under different market conditions than at origination. A 10-year permanent loan originated at 5% with a 25-year amortization schedule will have a substantial balloon at year 10 that must be refinanced. If rates have risen to 7-8%, the refinancing cost increases dramatically. Model the balloon payoff scenario using conservative future rate assumptions before accepting any permanent loan.
Bridge and Transitional Loans
Bridge loans serve properties that aren't yet ready for permanent financing. The bridge period allows the borrower to improve the property's income profile, complete renovation, or stabilize occupancy to the level permanent lenders require. Bridge loan risks are covered in detail separately, but the key discipline is having a verifiable, realistic exit strategy before accepting bridge financing.
Construction Financing
Construction loans fund ground-up development or major renovation through a draw-based structure. The lender controls when draws are released, creating leverage that can be used constructively or as a source of pressure. Construction loans require careful attention to draw conditions, inspector requirements, and what happens if the project encounters delays or cost overruns.
CMBS: Understanding the Securitized Market
CMBS loans are originated then sold into securitization pools where they're bundled with other loans and converted into bonds for institutional investors. Once securitized, the loan is governed by a Pooling and Servicing Agreement that tells the servicer exactly how to handle every situation. The servicer has limited discretion. This means flexibility when you need it most may not be available.
CMBS loans have historically offered competitive rates for qualifying assets. The rate advantage can be significant. The flexibility disadvantage can also be significant if you ever need a modification, an extension, or any deviation from the original loan terms. Understand this trade-off explicitly before accepting CMBS financing.
Agency Financing
Fannie Mae, Freddie Mac, and FHA/HUD provide financing for multifamily properties through the agency market. Agency loans offer very competitive rates, long terms, and non-recourse structures (for most programs) that provide meaningful protection for multifamily investors. The application process is more rigorous and time-consuming than many alternative sources, but the terms for qualifying assets are generally excellent.
Understanding Commercial Underwriting
Commercial loan underwriting is driven by income and value metrics that residential borrowers may not recognize. Understanding these metrics lets you evaluate whether a lender's underwriting is sound.
Net Operating Income
NOI is rental income plus other property income, minus operating expenses (property taxes, insurance, management, maintenance, utilities where owner-paid, and vacancy allowance). NOI does not include debt service. It's the income the property generates before any loan payments are made.
Debt Service Coverage Ratio
DSCR is NOI divided by annual debt service (principal plus interest). A DSCR of 1.25 means the property generates 25% more income than its debt service requires. Most commercial lenders require 1.20-1.35 DSCR at origination. Many loan covenants require maintaining a minimum DSCR throughout the loan term.
Loan-to-Value
LTV is the loan amount divided by appraised value. A $7 million loan on a $10 million appraised property is 70% LTV. Lower LTV means more equity cushion and less risk for the lender. Most commercial permanent lenders cap at 70-75% LTV.
Commercial Loan Red Flags
Several red flags appear consistently in problematic commercial lending situations.
Lenders who resist complete fee disclosure before commitment. Every legitimate commercial lender can provide a comprehensive fee schedule. Reluctance to provide complete written fee information is a significant warning sign.
Extension conditions that are entirely at the lender's discretion. For transitional loans, extension conditions that require "lender's approval" without specified criteria give the lender complete control at maturity. This creates risk of manufactured distress at the balloon date.
Underwriting that ignores DSCR in favor of collateral coverage. Lenders who fund deals without adequate income coverage are positioning for default, not repayment. Ask specifically about the DSCR required for your loan and verify it independently.
Floating rate loans without clear caps. Uncapped floating rate loans create unlimited interest rate risk. If a lender offers a floating rate commercial loan without discussing interest rate caps, ask about them specifically. Many bridge loan structures require interest rate cap agreements.
How to Use Coventry Enterprises Resources
The full suite of Coventry Enterprises resources covers commercial lending in detail. The commercial real estate financing guide provides the comprehensive overview. The due diligence checklist provides the practical framework. The commercial loan pitfalls guide covers structural issues common across loan types. And the consulting services are available for borrowers who need independent review of specific commercial loan situations.
Frequently Asked Questions
What types of commercial loans exist for real estate?
Permanent mortgages for stabilized properties, bridge loans for transitional situations, construction loans for development, SBA 7(a) and 504 for owner-occupied, CMBS securitized loans, agency multifamily financing, and portfolio loans held by originating lenders.
What underwriting standards do commercial lenders use?
Commercial underwriting focuses on Debt Service Coverage Ratio, Loan-to-Value, debt yield, and borrower creditworthiness and experience. Most lenders require minimum DSCR of 1.20-1.35 and LTV below 75-80%.
What are the red flags in commercial lending?
Resistance to complete fee disclosure, extension conditions entirely at lender discretion, technical defaults unrelated to payment, uncapped floating rates, guaranteed approval claims, and changing terms between commitment and closing.
How is commercial lending regulated?
Less than residential lending. TILA and RESPA generally don't apply. This lighter regulatory environment puts more responsibility on borrowers to protect themselves through due diligence and contractual protections negotiated before signing.