Owning commercial real estate comes with tax, financial and other benefits. Many businesses across industries choose to purchase owner-occupied commercial real estate, so they can realize these diverse benefits. Here’s a look at what owner-occupied commercial real estate is.
Purchasing commercial real estate can be a great way to invest in your business’s future. However, financing these types of properties comes with its own unique set of challenges. One option that can make financing commercial real estate more accessible is an owner occupied real estate loan.
As the name suggests, an owner-occupied real estate loan is financing for property that a business uses as its primary place of operation. The owner must occupy more than half of the building’s leasable space to qualify This type of loan opens up more options since lenders view owner-occupied properties as less risky
In this article, we’ll break down everything you need to know about owner occupied real estate loans. Here’s what we’ll cover:
- What is an owner occupied real estate loan?
- Benefits of owner occupied real estate loans
- Types of owner occupied real estate loans
- Qualifying for an owner occupied real estate loan
- Finding the right lender
- Drawbacks to consider
- Alternatives to explore
- FAQs
Let’s get started!
What is an Owner Occupied Real Estate Loan?
An owner occupied commercial real estate loan is a mortgage used to purchase or refinance a property that the business owner uses as their main place of operation
To qualify for an owner occupied real estate loan, here are some key requirements:
- The owner must use at least 51% of the building’s leasable space for their business purposes.
- The owner cannot lease more than 49% of the building’s space to other tenants.
- The owner must move into the property within 60 days of closing on the mortgage.
- The owner must use the property as their primary place of business for at least 1 year.
These occupancy requirements allow the property owner to access more favorable loan terms reserved for owner-occupants.
Benefits of Owner Occupied Real Estate Loans
There are several advantages that come with financing commercial real estate through an owner occupied real estate loan:
More Affordable Financing Terms
Lenders offer lower interest rates and down payments for owner occupied commercial loans since the borrower also operates their business out of the property. This makes payments more affordable.
Access to Better Loan Programs
Options like SBA loans and FHA loans have attractive terms but are reserved for owner-occupied properties.
Potential for Added Income
The owner can collect rental income from portions of the building they don’t occupy. Extra income helps cover the mortgage payment.
Increased Loan Approval Odds
Lenders perceive owner occupied properties as less risky. Therefore, approval odds are higher than loans for pure investment properties.
Tax Write-Offs
Expenses like mortgage interest, repairs, and maintenance can be written off since the property is used for business purposes.
More Control
Since the owner works onsite, they can closely monitor tenants and quickly handle any maintenance issues that arise.
Types of Owner Occupied Real Estate Loans
You have several loan programs to choose from when financing an owner occupied commercial property:
Conventional Loans
A conventional loan is a standard mortgage that is not backed by the government. Down payments are typically at least 15-20% of the purchase price. Interest rates are determined based on current market conditions and the borrower’s credit profile.
SBA 7(a) Loans
7(a) loans are backed by the Small Business Administration and issued through approved lenders. Loan amounts up to $5 million are available for purchasing, constructing, or renovating owner occupied real estate.
SBA 504 Loans
The SBA 504 loan program provides financing up to $5 million for owner occupied commercial real estate. The loan is structured with 10% borrower equity, 40% from a private lender, and 50% guaranteed by the SBA.
FHA Loans
FHA loans are a great low down payment option, requiring just 3.5% down for owner occupants. These mortgages are backed by the Federal Housing Administration and issued through approved lenders.
Qualifying for an Owner Occupied Real Estate Loan
While owner occupied financing offers more flexibility, you still need to meet certain criteria to qualify:
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Credit score: Most lenders look for a minimum score around 620-650. The higher your score, the better your interest rate.
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Down payment: At least 10-25% is typically required. Programs like FHA and SBA loans allow lower down payments.
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Debt-to-income ratio: Your total monthly debt payments (including the new mortgage payment) should not exceed 43-50% of your gross monthly income.
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Commercial real estate experience: Having experience as a commercial real estate investor or business owner improves your chances of approval.
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Property criteria: The property should be zoned for commercial use with proper permits and occupancy codes. Industrial, retail, office space, and warehouses are commonly financed.
As an owner-occupant, make sure to find a property suited for operating your type of business. If zoning laws and business permits don’t allow it, move on to other property options.
Finding the Right Lender for an Owner Occupied Loan
With an owner occupied real estate loan, you aren’t limited to big banks and credit unions. Here are some recommended lending options:
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Community banks: Local banks are often open to financing owner occupied properties, even for first-time commercial buyers.
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Credit unions: Member-owned credit unions offer competitive rates and more flexibility than big banks.
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Mortgage brokers: A broker shops your application to multiple lenders, helping you find the best fit. Brokers charge an upfront fee for their services.
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Commercial mortgage lenders: Specialized commercial lending companies like CDFIs provide owner occupied real estate loans across the country.
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SBA lenders: Banks, credit unions, and other lenders who participate in SBA loan programs.
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Online lenders: Financial tech lenders provide easy online applications and fast access to financing. However, interest rates may be higher.
I recommend getting rate quotes from multiple lender types to find the most competitive terms for your business situation.
Drawbacks to Consider with Owner Occupied Loans
While owner occupied commercial loans provide small business owners with a financially viable path to purchasing real estate, there are some potential drawbacks to consider as well:
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Being too reliant on rental income to cover the mortgage payment adds risk should vacancy rates rise.
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If the business fails or you choose to move, selling a property zoned for commercial use could pose a challenge.
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As the tenant pool changes over time, extensive renovations may be required to keep attracting clients. Added maintenance costs can cut into cash flow.
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If you don’t properly screen tenants, you could end up with unreliable ones that jeopardize your income streams.
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Excess noise or foot traffic from tenants could disrupt your daily business operations.
For these reasons, have a plan for handling vacancies and vet prospective tenants thoroughly before leasing space in your owner occupied property.
Alternatives to Owner Occupied Commercial Loans
If you want to finance investment properties that won’t be owner occupied, here are two options to consider:
Conventional Investment Property Loans
You’ll need a 20-25% down payment and solid credit score for a conventional rental property loan. Interest rates are also typically higher than owner occupied loans.
Hard Money Loans
A hard money loan is an asset-based loan with interest rates starting around 7-12%. You’ll need 25-35% down and can expect to pay 2-5 points upfront. Hard money loans fund quickly but should be used as a short-term solution.
FAQs about Owner Occupied Commercial Loans
Can I get an owner occupied loan for a mixed-use property?
Yes, as long as over 51% is owner occupied. For example, you could operate your business on floors 1-3 and rent out floors 4-5.
What commercial spaces qualify for owner occupied loans?
Industrial, retail, office, medical, multi-family (under 4 units), gas stations, churches, warehouses, and assisted living homes often qualify.
Can I purchase the commercial property through my business instead of myself as the owner?
No. To qualify for an owner occupied loan, you as the individual business owner must be both the occupant and property owner.
How much income documentation is required?
Expect to provide personal and business tax returns, bank statements, profit and loss statements, and other income documentation.
Can I purchase an existing building or do construction loans exist?
You can use an owner occupied loan to either purchase an existing building or construct a new one tailored to your business through a construction loan.
The Bottom Line
An owner occupied commercial real estate loan allows entrepreneurs to purchase a property suited for housing a business, while reaping the benefits of more favorable loan terms. Just be cautious with relying heavily on rental income and have a plan to cover expenses if vacancy rates rise. And always work with a qualified commercial lender who can guide you through qualifying, finding the ideal property, and securing the best financing terms possible.
What Does Owner-Occupied Commercial Real Estate Mean?
Owner-occupied commercial real estate is property that’s both owned and used by the same business. The business usually needs to use at least 30 or 50% of the property, depending on the specific program being considered. Most programs also consider properties that are used and owned by distinct entities within a single umbrella business to be owner-occupied.
Most types of commercial real estate can qualify as owner-occupied commercial properties. Retail stores, medical offices, office buildings, industrial buildings and flex space can all be owner-occupied. So too can specialty properties, such as those used for self-storage facilities, assisted living/skilled nursing facilities, daycares, event centers, sports stadiums, and more.
Multifamily properties are one exception that’s not recognized as owner-occupied. Hotels and various mixed-use spaces can be classified as owner-occupied, though.
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What Are the Pros and Cons of Owner-Occupied CRE Property?
Owner-occupied commercial real estate properties aren’t right for every business. These properties have many advantages that make them worthy of consideration in most instances, though.
The benefits of owner-occupied commercial real estate include both financial and other benefits.
- Build Equity: A portion of the monthly mortgage that’s paid on owner-occupied CRE goes toward the mortgage’s principal. The amount of principal that’s paid of is turned into equity, which grows slowly over time as a loan is repaid. In contrast, lease payments don’t generate any long-term equity.
- Capitalize on Appreciation: Should an owner-occupied commercial property’s value appreciate, the appreciation can greatly boost a business’ assets. The added property value can be realized by selling the property, or by executing a cash-out refinance. Businesses benefit from any appreciation regardless of whether they own a property outright or have used financing.
- Rent Vacant Space: Vacant space in the owned property can be rented, either for the short-term or long-term. Any rental income received can be treated as additional revenues.Renting out vacant space can be an especially effective tactic for growing businesses. Extra space can be temporarily rented while it’s not needed, and the payments received can be directed to spur further growth. The leases don’t have to be renewed once the space is needed.
- Reduce Taxes: Certain expenses related to owning and maintaining a property can be written off when a business owns the property. Things like property taxes and mortgage interest don’t qualify as write-offs when a business is leasing. Since there are many costs associated with maintaining commercial real estate properties, the tax deductions are frequently quite substantial.
- Control Property: When a business owns the property that it’s in, the business can do with the property as it wishes. There aren’t any constraints placed by third-party property owners that must be adhered to. Additionally, businesses may be more willing to invest in valuable upgrades if they’ll see the increased value whenever the property is sold. (Laws and codes, of course, still apply.)
- Stabilize Payments: if an owner-occupied property is financed through a fixed-rate mortgage, then the monthly payments for the property will remain constant for the duration of the mortgage. For businesses that don’t own property, monthly lease payments can jump every time a lease has to be renewed.
- Diversify Assets: For businesses that have substantial assets, investing in owner-occupied commercial real estate could offer a way to diversify the business’ holdings.
The disadvantages of owner-occupied commercial real estate primarily relate to the added work involved, although there are some others to consider:
- Maintenance: Simply maintaining a property can become a significant time sink. Maintenance of commercial real estate should be outsourced to reduce how much time is spent on non-core tasks. However, business owners are often still surprised at how much work is involved with maintaining commercial real estate.
- Tenants: When extra space is rented to tenants, renting or leasing presents a variety of hassles and risks. Businesses must be willing to find new tenants, and respond to existing tenants’ calls/emails. Businesses also may need higher general liability insurance limits, and some rent-specific insurance coverages.
- Capital: Owning property requires a sizeable capital investment in an asset that doesn’t directly yield business growth. Even financing property usually requires 20% down, which can easily be tens of thousands. Businesses that are growing may not have the capital needed to purchase property, or they might not want to tie up so much capital that could otherwise more directly promote further growth.
- Depreciation: In the unlikely event that an owner-occupied property depreciates in value, the owning business would have to sustain the loss.