Key Takeaways
- Types of CRE debt include permanent, construction, bridge, mezzanine loans, and debt funds, each offering distinct structures, repayment terms, and use cases across various project stages.
- Loan structure and risk vary by financing type; debt funds offer flexibility but higher rates, while bank loans are more standardized with strict eligibility and lower rates.
- Core financing steps involve pre-qualification, document submission, negotiation, and closing, with clear expectations at each phase to streamline funding and reduce delays.
- Agora’s debt tools automatically track lender positions and maturity dates in the cap table, and offer lenders a dedicated portal to access tailored debt data.
- Strategic loan alignment with investment goals, maintaining prudent leverage, and monitoring debt performance are best practices to mitigate refinancing risk and improve returns.
In commercial real estate, knowing how to leverage debt financing can be the difference between a poor and a stellar investment. However, to take full advantage of CRE debt, you must understand how it works, its risks, and how to assess loan terms.
What is commercial real estate debt financing?
CRE debt financing is borrowing money to purchase, refinance, or develop commercial properties. The loan is typically secured by the property and has a fixed term, after which the remaining loan balance must be repaid or refinanced.
Comparison with related financing options
That said, CRE debt financing is not to be confused with commercial real estate equity financing. Let’s compare the two:
| Debt financing | Equity financing | |
| Definition | Borrowing money to fund a property | Raising capital by selling ownership stakes |
| Ownership | Sponsor retains full ownership | Sponsor gives partial ownership to investors |
| Collateral | Usually secured by the property itself | No collateral beyond ownership stake |
| Control | Sponsor retains full control of property decisions | Sponsor may allow some input from investors |
Within debt financing, there are also real estate debt funds and bank loans. Here’s how they compare:
| Debt funds | Bank loans | |
| Definition | Investment vehicles that pool capital from investors to provide loans to CRE projects | Traditional loans provided by banks to finance CRE projects |
| Loan structure | Flexible | Standardized mortgage with fixed terms and rates |
| Interest rates | Higher | Lower |
| Eligibilty | More lenient qualification criteria | Limited to borrowers who meet strict requirements |
Types of commercial real estate debt financing
Let’s take a closer look at the main types of commercial real estate debt financing:
Debt funds
Commercial real estate debt funds are investment vehicles that pool capital from investors to finance commercial real estate projects. Fund investors earn returns from loan interest, while borrowers benefit from a more flexible source of commercial real estate financing than traditional banks.
Permanent loans
Permanent loans are long-term commercial real estate loans that generally replace a construction loan after a commercial real estate project is complete and stabilized. They’re technically not permanent, but the name distinguishes them from relatively short-term construction loans.
Construction loans
Construction loans are short-term loans designed for building or renovating a property. They often require interest-only payments during construction, with the loan either converted to a permanent mortgage or paid off in full once the project is complete.
Bridge loans
Bridge loans are short-term commercial real estate loans meant to bridge the gap between when you purchase a property and when you sell or refinance it. They can be used to flip a property or acquire one quickly while you secure permanent financing.
Mezzanine financing
Mezzanine financing is a mix of debt and equity financing designed to fill funding gaps on a project. It typically sits between senior debt and equity financing in the capital stack.
Who’s involved in CRE debt financing?
Debt financing involves three key players:
- Borrowers: investors, developers, owners
- Lenders: banks, private equity, institutional lenders
- Intermediaries: brokers, advisors
When all three work together, funding a project can be a smooth process.
Key features of CRE debt financing
Before pursuing CRE debt financing, here are some key features to be aware of:
Loan-to-value ratios
Most lenders set a maximum loan-to-value (LTV) ratio at which they’re willing to lend. It measures what proportion of the property’s value is being financed. For example, an $800,000 loan on a $1 million property would have an LTV of 80% ($800,000 / $1,000,000 = 0.8).
Interest rates and repayment terms
Interest rates can be fixed or variable. A fixed rate offers predictable payments and interest costs, whereas a variable rate can fluctuate, carrying more risk.
Meanwhile, you may be required to make interest-only payments or interest-and-principal payments. Either way, you’ll often owe a balloon payment when the loan expires (unless the loan is fully amortized).
Recourse vs. non-recourse loans
Commercial real estate loans can be recourse or non-recourse. Recourse loans hold the borrower personally liable for the debt, whereas non-recourse loans generally limit the lender’s recourse to the collateralized property if the borrower defaults, though exceptions may apply.
Covenants, conditions, and restrictions (CC&Rs)
Covenants, conditions, and restrictions (CC&Rs) are legally binding rules recorded with a property that govern how it can be used or developed. As a result, lenders look at them when deciding whether to finance a property.
Process of securing CRE debt financing
Here are the main steps in securing CRE debt financing:
1. Pre-qualification
First, you must pre-qualify for CRE financing by sharing basic details about your company and the project with a lender. They’ll tell you if the deal has potential. You may want to pre-qualify with a few lenders to compare loan terms.
2. Loan application and documentation
Next, submit a full loan application with your lender of choice. You may need to include an offering memorandum, rent rolls, and other required documents. That way, the lender can review your credit, income, and commercial real estate assets as well as the property’s market value and cash flow projections.
3. Negotiation
After reviewing the project, the lender will make a loan offer. You can choose to accept it or negotiate for better terms. For example, you can try to negotiate lower fees or interest rates. However, don’t expect significant changes from the initial loan offer.
4. Closing and disbursement
Once you and the lender agree on loan terms, you can move on to closing. This is when you finalize the deal by signing legal documents. The lender will then release the loan funds, and you’ll start making any loan payments.
Pros and cons of CRE debt financing
Of course, CRE debt financing has its pros and cons. Consider the following:
Pros
- Enhances project capital structure: Debt lets you fund larger projects with less equity, creating a more efficient use of your capital.
- Improves investor return potential: By using debt leverage, you can magnify equity returns when the property performs well.
- Supports portfolio risk management: Debt can help you spread your equity across more properties, limiting the amount of equity that is at risk in any single asset.
- Offers predictable repayment costs: Fixed loan terms make it easy to plan for future loan debt service costs.
Cons
- Exposure to refinancing risk in volatile markets: If credit conditions tighten or interest rates rise, refinancing at loan maturity can become more expensive or impossible.
- Potential for default under financial stress: If the property’s rental income drops or expenses rise, it may be unable to cover its loan payments.
- Reduced liquidity and flexibility once debt is locked in: Loan terms can limit your ability to sell, reposition, or restructure the property without the lender’s consent.
Risks and challenges in CRE debt financing
To make an informed borrowing decision, you must also understand these risks and challenges:
Regulatory and compliance hurdles
To qualify for CRE debt financing, you must ensure your property meets local commercial real estate regulations, such as zoning laws, building codes, and environmental standards. Failure to comply can delay funding or even lead to legal penalties.
Valuation and appraisal risks
If a property appraises lower than expected, the lender may reduce the loan amount or require a larger down payment, disrupting your investment plan. Keep in mind that appraisals are sensitive to market conditions, and even small shifts can impact the property’s value.
Market downturns and refinancing pressures
In a declining commercial real estate market, property income and values may fall, making it harder to make loan payments or refinance when the loan matures. Rising interest rates and tighter credit conditions can make it even harder.
Expert Tip: Optimize CRE debt for strategic flexibility, not just leverage
- Structure debt to match your business plan, not just for maximum leverage. Align loan maturities and covenants with hold periods, cash flow ramps, and exit strategies.
- Use non-recourse carve-outs strategically. Avoid blanket guarantees, but understand what “bad boy” provisions mean operationally, they’re often triggered by common missteps like unauthorized property transfers.
- Monitor interest rate reset risk on bridge and mezzanine layers. Rate spikes can erode DSCR buffers and impair exit refinancings.
- Consolidate lender data into your cap table tools. Tracking terms, rates, and maturities at the position level enhances your ability to manage extensions, paydowns, and recapitalizations across multiple assets.
Miles Hector is a Solutions Engineer at Agora in New York. He began in ABS and derivatives at Bank of America Merrill Lynch before moving into real estate private equity, focusing on infill development financing in the Western U.S., particularly Los Angeles County.
Best practices for CRE debt financing
To get the most out of CRE debt financing, follow these best practices:
How technology is transforming CRE debt financing
CRE debt financing has been around for a long time, but modern technology is making it faster and more accessible than ever.
For example, online commercial real estate lending platforms and digital marketplaces make it easier to apply for CRE financing. Furthermore, AI-driven risk assessment algorithms can help lenders quickly determine whether a project is viable.
At Agora, we’ve also made it easier for deal sponsors to manage debt. Our platform automatically creates lender positions in your cap table with detailed debt terms and maturity dates. Plus, you can provide lenders with a dedicated portal to showcase tailored debt metrics.
Conclusion
A well-planned debt strategy can enhance your investment performance—but only when you carefully weigh your financing options and understand the risks involved.
By doing your due diligence, maintaining healthy leverage, and building strong relationships with CRE lenders, you can unlock higher returns than you could with equity financing alone. Furthermore, with Agora’s debt management features, you can streamline capital raising, track lender positions, manage your debt portfolio, and ultimately make smarter financing decisions.
