How Much Down Payment Do I Need for a Commercial Business Loan?

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An investment in commercial real estate can transform your business from a subsistence livelihood to a retirement plan. Instead of making rent payments to a stranger or real estate mogul, you can redirect this tax-deductible expense toward building up an asset that will sustain you far into the future. Buying commercial real estate may be the most important business move you ever make, so be sure to do your homework and get your ducks in a row before setting the process in motion.

TL;DR (Too Long; Didn't Read)

The minimum down payment for commercial property is usually 20 to 30 percent of the real estate's cost. However, a Small Business Administration, or SBA, loan down payment for real estate is usually considerably lower, requiring just 10 percent of the property's price.

Commercial Real Estate Lending

Business loans for operational purposes are notoriously hard to come by. When you ask a bank to finance a venture such as a new product, you're asking that lender to see value in an asset that may likely pay off only for your specific business if your venture is successful.

Business infrastructure such as custom packaging or leasehold improvements may improve the value of your company if your strategic plans come to fruition, but if your venture fails, the bank is unlikely to recoup its money by selling off your labels or the plumbing you've built into a property you no longer lease. The uniqueness of each business makes operational small business lending difficult for entrepreneurs and risky for investors.

In contrast, a commercial real estate investment provides something of real value for loan security. If you don't make your payments, the bank can seize and resell your building, quite possibly making back the entire amount you were unable to repay. This extra security for commercial real estate loans as compared to other business financing makes it easier to borrow money to buy property than to upgrade equipment. However, you must be able to also make a significant business loan down payment if you're buying commercial real estate.

The SBA Loan Down Payment

Real estate loans are the most common type of SBA loans to require down payments, but other types of SBA loan products may require some type of down payment as well. A construction or inventory loan may have a down payment component, especially if your venture is somewhat risky. The down payment shows the lending institution that you're serious about your commitment and you're willing to have skin in the game.

Very small SBA loans (microloans) may not have down payment requirements, nor do credit lines secured through the SBA's CAPlines program, which are more like revolving lines of credit than a term loan. SBA export loans don't take down payments because their purpose is to facilitate export rather than creating hurdles, and SBA disaster loans are for urgent situations when cash is typically tight.

How SBA Loans Work

The SBA is a government agency that facilitates small business lending. The SBA doesn't actually provide direct loans to companies but rather works with banks and guarantees the loans made by these other financial institutions. The SBA also works with certified development corporations, which are nonprofit organizations founded with the primary purpose of administering small business loans backed by the SBA.

By guaranteeing small business loans, the SBA lessens the risk that a lending institution takes when lending to a small business. This allows lenders to ask less for an SBA down payment than they would for a traditional type of business loan. Aside from the size of the down payment for a commercial real estate deal, the criteria for SBA-backed loans are very similar to the requirements for other types of business lending. You still have to show that your business is viable, that your books are in order and that you're earning enough to more than cover your loan payments.

Types of SBA Loans

An SBA 504 loan is designed primarily for purchasing assets such as real estate and major pieces of equipment. SBA 504 loan amounts start at $125,000 and can reach over 20 million dollars. Loan periods are 20 years for real estate and 10 years for equipment. An SBA loan down payment for the 504 program is typically 10 percent of the cost of the real estate.

The SBA 7(a) loan can also be used for commercial real estate or equipment purchases, but it allows for considerably more flexibility. You could also use a 7(a) loan for packaging upgrades or leasehold improvements if you have sufficient collateral to back up your borrowing. The loan term for a 7(a) loan for commercial real estate is more flexible than for an SBA 504 loan, sometimes extending to 25 years. The down payment requirement of 10 percent is the same for both loan products.

Preparing for a Commercial Mortgage

Whether your commercial real estate loan down payment is the 10 percent required by the SBA or the 20 to 30 percent required for a traditional bank loan, you'll increase your odds of securing financing if you do your homework and make a strong presentation.

It helps to develop a working relationship with a banker so that even if you're not ready to buy commercial real estate at the moment, you can make it part of your long-term planning. A business banker can advise you about how to build your business to qualify for financing down the line, and seeing you evolve as an entrepreneur may encourage that lender to go to bat for you once you do apply for a loan.

Prepare a business plan to submit with your commercial loan application. Your business plan should tell your company's story and also project how your narrative will play out over time, especially once you make your commercial real estate investment. Include your bio and experience and also bios for managers or key employees. Also prepare a detailed marketing plan and a thoughtful set of financials.

Business Loan Application Financials

  • Profit and Loss: You'll be asked to provide several years' worth of profit and loss statements for your commercial or SBA loan. These documents will reflect both your gross and net sales, giving the banker information about whether your business model earns you enough to make payments on a commercial real estate loan.

  • Balance Sheet: Your balance sheet shows how much you own, how much you owe and how much liquidity you have in case you need emergency cash. Your balance sheet gives a banker an idea of whether you'll be able to comfortably make your business loan down payment and whether you'll have some cushion for unforeseen situations. It also shows whether you have additional monthly loan payments, which may affect your ability to pay your mortgage.

  • Cash Flow Projections: Cash flow pro formas show lenders how your assets and earnings will play out over time. Obviously, you don't have a crystal ball to make projections, but you can use records from comparable periods and figure in anticipated developments to get an idea of what to expect as far as how funds will flow in and out of your business while you're making your mortgage payments. Your cash flow pro forma will also give your banker an idea of how realistically you're able to forecast and whether you're thorough in evaluating variables.

Loan Down Payment Variables

If you don't get an SBA loan, your business loan down payment will likely be at least 20 to 30 percent of the property's assessed value. However, there's a big difference between 20 and 30 percent, especially when you're dealing with hundreds of thousands of dollars.

The difference between a 20 percent down payment loan and a 30 percent down payment loan may depend on the likelihood that the property will be able to earn money for you once you buy it. Raw land either needs to be developed or rented out at low rates without amenities, so lenders will hedge their risks by asking for larger down payments.

Investment in property that needs to be developed is more speculative than investment in property with finished buildings and long-term tenants. The latter comes with both collateral and income, so your loan prospects are more secure, and your down payment will be lower.

Other Business Loan Costs

Your business loan down payment for real estate requires you to have ready cash, but it isn't the only major expense you'll encounter during the process. You'll need to have your building inspected to meet the bank's requirements and also as insurance against making an investment that needs urgent repairs and upgrades.

You'll also have to pay earnest money and fund the environmental inspections required by the Environmental Protection Agency. It's also good practice to hire an attorney to go over your documents before closing.

Do your homework and plan for all of these extra expenses, which can rear their ugly heads at a time when you're already feeling desperately strapped for cash. Including them in your financial projections shows the bank that you're thorough and proactive. Planning and strategizing about how to have the necessary funds available will also make things run more smoothly and preempt unnecessary last-minute headaches.

Get Ready Early

A commercial real estate loan may be the biggest investment you make in your entire business career. It may take years of planning and building the credentials and track record that will make you a sound loan prospect. Start early in preparing and learning about the process so you'll be ready to act when the time is right. Even if you don't actually end up buying commercial property, the steps you take will no doubt be good for your business.

Here are some steps you can take to get ready for your commercial real estate journey:

  • Make a profit. Lenders will understandably be more enthusiastic about lending to a business that is making money than one that is hemorrhaging capital. The more your business earns, the better it will be able to support you personally, pay your lenders and stay afloat. Take a close look at your business model or the ways your company earns and spends its revenue.

  • Clean up your books. Accounting is more than just a chore. It's a way for you to gather information and identify what's working and what's not in your business. In addition to providing you with valuable feedback, your accounting system shows a lender how well you understand and attend to your money. Even if you don't do your own bookkeeping, you should at least understand the system well enough to field questions that will inevitably be part of the loan process.

  • Check out commercial real estate listings. Develop a sense of what you're looking for, including size, price range and neighborhood. If you're knowledgeable about prices in your area, you'll be able to recognize a good deal when you see it. You'll understand whether your plans are realistic and how to temper them if they're not.

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About the Author

Devra Gartenstein founded her first food business in 1987. In 2013 she transformed her most recent venture, a farmers market concession and catering company, into a worker-owned cooperative. She does one-on-one mentoring and consulting focused on entrepreneurship and practical business skills.