Buying Investment Property with a Commercial Real Estate Loan vs Conventional Mortgage

When purchasing real estate, investors have two main property loan categories to choose from: commercial and residential. Both can be fantastic business opportunities, but if you’re weighing your investment options, you’ll want to carefully consider the differences between the two when it comes to financing, benefits, and drawbacks.

Not sure where to start? Here’s a basic guide of what you need to know for buying property with a commercial loan versus a conventional (consumer) real estate loan.

What is the difference between a property that can be bought with a mortgage vs a commercial loan?

The fundamental difference between commercial real estate loans and consumer home loans is the size and intended use.

• Consumer loans are used for single-family homes and one to four-unit residences— so think houses, condos, duplexes, and quadruplexes.
• Commercial real estate loans are used to purchase buildings that don’t fall in that category, like rental property with five or more units, apartment complexes, multiple investment properties, office buildings, retail spaces, warehouses, and other special-purpose buildings.

Above five properties, you may want to start looking for a commercial real estate loan.”

According to the standards regulated by Fannie Mae, you can buy up to ten investment properties with conventional mortgage loans. However, a lot of mortgage lenders will only underwrite up to five properties because of risk and the complexity of underwriting. Above five properties, you may want to start looking for a commercial real estate loan.

Conventional Home Loans vs Commercial Real Estate Loans

If you don’t have enough money on hand to cover the cost of your investment purchase, you’ll need to head down to the bank for a loan. But commercial and conventional lending are two different beasts, and it’s important to understand the differences between the two.

Getting a Conventional Mortgage

If you’re already a homeowner, you’re probably somewhat familiar with mortgage loans. A mortgage for an investment property is very similar to a primary residence mortgage. Here’s what you should keep in mind about mortgage loans for investment properties:

• The application process: When you apply for a mortgage, the lender will look closely at your personal finances. They’ll want to see your income, credit history, and personal debts. Compared to commercial property loans, mortgages are often easier to qualify for.
• Down payment: Banks will want to see you put down at least 20-25% of the property’s value if you don’t plan on inhabiting it. Compare this to the low 3.5% down payment minimum required for a primary residence FHA loan.
• Loan term: Mortgages are typically repaid over 30- or 15-year terms, even if it’s an investment property.
• Interest rates: Interest rates for investment properties are usually higher than a primary residence loan, but lower than a commercial loan.

Remember, these can only be used on residential properties with four or fewer units. For anything bigger, you’ll need a commercial loan.

Getting a Commercial Real Estate Loan

Commercial real estate loans come in many shapes and sizes. For many, their flexibility makes them the loan of choice for investors— even if they could technically use a conventional mortgage.

Here are the basics of a commercial property loan:

• The application process: It is typically harder to qualify for a commercial loan. Because there is more money on the line, banks will have stricter requirements. A lender will also want to investigate the earning potential of your investment property.
• Down payment: Down payment requirements depend on the loan type and the lender. Some commercial loans may have a 15% down payment minimum, while others may be as high as 35%.
• Loan term: Commercial loans typically have a much shorter repayment period. Instead of spreading out payments over 30 years, be prepared to pay back the lender in 10-20 years— or less. This can usually be negotiated with the lender.
• Interest rates: Rates will depend on the loan product but are usually higher than a mortgage.

Because the needs of commercial investors can be so unique, it’s important to work with a lender with plenty of commercial lending experience. They can help you craft a loan that works with your specific situation.

Pros and Cons: Single-Family Dwelling vs Multi-Family Dwellings

Although there are many ways to own investment property, let’s take a closer look at one of the most striking comparisons: owning a single-family dwelling vs a larger property with five units or more. Whenever you’re looking for investment properties, it’s worth the time to consider every aspect of the commitment, including upfront investment, cash flow opportunity, tenant relationships, and risk.

	Single-Family Dwelling	Larger Property with 5+ Units
Loan Options	Mortgages are typically easier to qualify for than commercial loans but are usually more restrictive.	There are many different loan options available for commercial real estate investing. Loan terms can also be flexible, meaning you can work with a lender to craft a loan that fits your needs. However, they can be more difficult to qualify for.
Upfront Investment	Investing in a single-family property can mean a lower barrier to entry. A down payment for a small home will be much smaller than what you would need for a large multi-family dwelling.	Larger properties that need a commercial real estate loan may also require a larger upfront investment because of high down payment requirements and higher property values.Larger spaces also come with bigger expenses if you need to do work to get the property move-in ready.
Cash Flow Opportunity	Even if you aren’t raking in as much as you would with a larger property, there is still a sizable cash flow opportunity to consider with a smaller rental property.	Multi-family properties with over four units have a huge cash-flow opportunity. Historically, these investments have a much higher return on investment (usually between 6% and 12%) compared to single-family properties.Businesses can also take advantage of economy of scale. The larger the business, the larger the savings.
Vacancy	If you have a single-family unit and it’s empty, you’re not pulling in any income at all!	If you have twenty units and one of them is empty, you’re still pulling in income.
Property Management	Single-unit property management can be a DIY duty or hired out to a property management company.Keep in mind that doing it yourself can be a large time commitment, especially if you’re buying multiple single-family properties.	Bigger spaces equal bigger problems. For instance, a plumbing issue in an apartment complex might turn into a larger issue than a typical household plumbing problem.Many investors take advantage of a property management company to handle any day-to-day issues that arise.
Overall Complexity	Owning and managing a single-family unit is a lot simpler. There may be less potential for income, but it may be the right fit if you’re just starting out.	Owning an apartment building is a huge responsibility, but also has the potential for huge rewards. If you’ve never operated as a landlord before, it can be intimidating.

Get Started with Property Ownership

Though they both make great real estate investments, residential and commercial properties are very different in terms of their financing, advantages, and disadvantages. Finding the one that’s right for you will depend on how much money you want to spend, how much time you want to commit to the investment, and how much risk you’re willing to take.