Commercial Real Estate Loan Basics

Real estate loans - deciding whether to be a borrower or investor

Considering a commercial real estate loan? Despite rising interest rates in the commercial capital markets, buying does have its advantages. Although the advantages depend upon your situation and the type of business you’re in, some of the monetary benefits of buying are:

• Interest on the commercial real estate loan is tax deductible
• You can take annual depreciation deductions on your taxes
• In the long run, you’ll probably come out ahead because you won’t be facing rent increases
• You’ll benefit financially if the real estate market is good when you sell
• You may be able to lease out a portion of the building if you determine you have excess space
• If you need to make substantial changes to the building to accommodate your business, those changes are owned by you rather than your landlord

The non-monetary benefits of buying and carrying a real estate loan are as follows:

• You can make any changes you want to the property
• The hours of your business can be whatever you want them to be
• You are free to stay in the same location as long as you wish

Cash flow analysis of a real estate loan

In addition to reviewing the benefits above and considering your own circumstance, you should do a cash flow analysis to see which option makes more sense from a cash standpoint. To do this, you need to have all of the necessary information including the full cost of purchasing, the terms of the lease, the depreciated value of the property at the time you would want to move, an estimate of the property’s value at that time, estimates of maintenance costs, and your tax rates.

Complete cash flow budgets that include all of the expenses you would incur for either buying or leasing over a set period of time. For the lease analysis, you’ll need to determine your net cash outlay, which is the amount you end up spending on the lease once you’ve subtracted the tax savings you receive from it.

In order to make a direct comparison, you also have to take into considering the change in value of today’s dollar versus a dollar five years from now. This is known as the discount factor and can be calculated using most spreadsheet applications.

You’ll also have to know the amount of the interest deduction that you will get on your business’ taxes. You can arrive at this number by multiplying the interest rate of the real estate loan by each month’s preceding balance.

It becomes difficult to determine whether or not carrying a commercial real estate loan is more beneficial than leasing when it comes to estimating the value of the property when you would be selling the property. It is the value of the property at the time of sale that will ultimately determine whether or not it makes sense to buy or lease. Obviously, the longer you stay in the building, the better off you will be because you will be gaining more and more equity. However, do you know how long you will actually be there? Do you know what the real estate marketing is going to do in that time period? These questions are tough to answer.

The current market and your decision to apply for a real estate loan

The best way to choose whether or not to buy and carry a commercial real estate loan or lease is to study the current market, as well as trends and predictions for as far into the future as you can get. Keep in mind that the farther out the prediction, the less reliable it will be. Arm yourself with as much knowledge as you can, and then make your best estimate. You know your business and you should have a good idea where it’s headed. If you know you want to be in an area for the next 10 years or so, the market is strong, and you’ve identified a building that will suit your needs for that timeframe, then go for it. Ten years of equity can be substantial. If you get a good deal on the property then it makes sense to buy if you’ll be there for ten years. If you know the building is priced at or above the fair market value, or if you think five years may be more than the length of time you’ll be there then think about offering to lease.