Purchasing property, whether residential or commercial, often requires interested buyers to take out a mortgage. Residential mortgages are the most commonly acquired, while commercial mortgages are critical when you want to purchase real estate for your business or if your business is real estate.

There are different types of loans, lenders, and mortgage categories depending on the type of commercial property you’re interested in buying. When thinking about buying commercial real estate, there are certain stipulations that you need to consider. Primarily, you’ll want to know what your options are for commercial real estate loans, what the requirements are, and which mortgage category is right for you. The first step is to understand the commercial real estate credit landscape.

Agency Lenders

The two primary commercial real estate agency lenders are Federal National Mortgage (FNMA or Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). These agencies are government-sponsored entities (GSEs), which were founded to expand the secondary mortgage market. GSEs purchase loans from lenders to free up the lender’s capital in an effort to make more loans, thus increasing the amount of capital available. However, since GSEs were established with this mandate, there is a catch—they have certain rules and regulations that need to be met in order to be qualified for purchase by Fannie Mae or Freddie Mac.

While a large amount of Fannie Mae and Freddie Mac’s activity comes in the residential mortgage market, they also play a significant role in the commercial mortgage market.

Fannie Mae and Freddie Mac cover multifamily mortgages, which fall under the category of a commercial real estate loan. They insure loans that adhere to certain pre-approved standards in an effort to help stabilize the disparities in the U.S. housing financial system. These loans are considered securitized, non-recourse, and are often associated with long-term amortization.

Fannie Mae and Freddie Mac backed loans provide security for investors with principal and interest payment guarantees and insurance. They require both annual guarantee fees and loan-level price adjustments (LLPAs), which vary based on specifications of the loan.

Commercial Mortgage-Backed Securities (CMBS)

Commercial mortgage-backed securities (CMBS) don’t require the same rules for standardization as agency lenders and extend beyond residential and multifamily properties. CMBS can supply financing for different types of commercial property, such as hospitals, hotels, multifamily, industrial, etc.

CMBS are a mortgage pool, created by a lending institution (or “issuer”) who either buys or originates these loans according to a set criterion, which are then sold as bonds to investors. CMBS are generally made up of a varied pool of loans with many different property types and borrower profiles, which increases an investment’s diversification and lowers its risk. As a result of putting the investment together, the coordinating issuer is customarily paid a percentage of the value of the portfolio of loans throughout the continuation of service or if a third-party steps in to service the loans on the investor’s behalf. In the aftermath of the Great Financial Crisis, regulations were established that required CMBS issuers to hold onto 5% of any CMBS they supply, as a risk-retention tool so they maintain “skin in the game.”

Because CMBS are issued on the public markets, they are subject to regulations, which governs what CMBS issuers can and cannot do. This regulatory framework guides the types of loans available to be pooled into securities, meaning many borrowers’ do not qualify or fit the criteria due to their financing needs or situation.

If someone is considering using a CMBS loan, they have to determine which type will best fit their needs. CMBS are classified into different tranches, which are primarily determined based on credit risk. The lower your credit risk, the better quality CMBS you’re likely to be placed in. This makes it more difficult, and less appealing, for inexperienced and undercapitalized investors to utilize CMBS.

Banks and Credit Unions

For a more traditional mortgage assessment, those interested in acquiring commercial property can do so through banks and credit unions. When getting approved with these institutions, they will often retain ownership of the loan and keep it on their balance sheet while you continue to make payments. In this case, there are no third-party transferences so if you have problems, need to ask questions, or want to make transfers, you will correspond with them directly.

While banks are primarily for-profit entities, credit unions are not-for-profit institutions. They both make their own credit decisions when lending out their capital and they may specialize in property types, markets they serve, or different areas of focus. Banks and credit unions each have unique benefits and downfalls, so researching your options is essential for making a successful long-term decision.

Banks and credit unions provide the opportunity to create a relationship with your lender unlike any other, but you might be subject to that institution’s specialty or area of focus. Thus, the place you have a traditional “banking” relationship with might not be able to serve your needs. It’s important to understand this when choosing what banks and credit unions to work with.

Insurance Companies

Like CMBS, insurance companies are a special subset of investors in the commercial mortgage market. They can act as direct lenders or they can purchase loans originated by other lenders, which fit their own credit criteria. Insurance companies are usually not the most aggressive when it comes to leverage, so their loans are known to be more conservative and thus come with some the lowest interest rates in the market.

There are certain restrictions when using life insurance loans, as each company sets its investment criteria based on its own risk tolerance. Every insurance company has different requirements and payback options, so it’s important to discuss the details with your lender prior to making any decisions.

Debt Funds (Private Lenders)

If you want a more personalized approach, using a private lender offers distinct benefits. Private lenders are also considered debt funds and range from direct lenders offering permanent financing to hard money lenders offering bridge loans.

Many private lenders do not have the strict lending requirements that other lender types have, so they are often able to work with prospects on an individual basis to discuss the lending terms and simplify the qualification process. This allows for more flexibility, speed, and leniency in regard to underwriting. The cost for these benefits is that debt fund lenders typically have more expensive rate and fees than banks or credit unions.

Real estate is a relationship business. If you’re interested in learning more about mortgage categories and commercial lending, we can help. While securing real estate finance used to occur at your local bank or credit union with face-to-face interactions, those days are gone. At PACT Capital, we maintain the personal approach to real estate credit. So, when you need help determining what commercial mortgage type is right for you and your situation, please reach out to PACT Capital. We can help you secure the financing you need.

PACT Capital is a direct private lender and capital advisor specializing in commercial real estate credit with decades of business and credit experience. We’ve originated over $1B in loans together using the personal and tailored approach our clients know us for. Capital is our business, so let us help you source the capital you need to keep growing your business.