Using a business loan for rental property can help you grow a real estate portfolio by providing funds to purchase single or multiple rental properties and provide money for renovations and upgrades to increase rental income.
There are a wide variety of loan options for individuals, but finding a business loan for rental property can sometimes feel like running into a brick wall. Unless, of course, you know where to look!
We’ll explore the various business loan options available for rental property and discuss how Small Business Administration (SBA) loans can be used for real estate investment.
Key takeaways
- A business loan for real estate is an alternative to obtaining a loan with a personal guarantee.
- Many lenders place more emphasis on business assets and the rental property used as collateral when underwriting a business loan.
- Sources for rental property business loans include banks with which a company is already doing business and private and portfolio lenders.
- Two loan programs offered by the SBA to help a business purchase real estate for its own use are SBA 504 and SBA 7(a).
Business loan options for rental property
Here are some options to consider for getting a business loan when you begin looking for rental property.
1. Traditional bank loans
When shopping for a business loan for an investment property, the first stop is the bank or credit union with which you're already doing business. The odds are that the branch manager and many of the employees already know you by name and may welcome the opportunity to earn more of your business.
Applying for a business loan for rental property is similar to applying for a personal loan. Documents that lenders generally require include:
- Credit report showing a history of paying back loans on time
- Bank statements to document revenues and forecast future business cash flow
- Business tax returns showing the historical performance of your business as reported to the Internal Revenue Service (IRS)
- Profit and loss statement providing a lender with income and expense details over multiple periods
- Balance sheet reporting current assets and liabilities showing what your business owns and owes, along with owner’s equity
- Business plan and financial projections detailing what the loan will be used for, such as purchasing rental property, and cash-flow forecast demonstrating that the loan can be paid back
A lender may also ask for similar personal information and request a personal guarantee from company principals, even though your business is applying for a loan.
2. Business term loan
Traditional banks, credit unions, and private lenders offer business term loans. There are many term loan options with different loan sizes and interest rates. Term loans for businesses provide funds to buy equipment, update office space, and purchase real estate. Funds are received in one lump sum and paid back over a period of time, typically with a fixed interest rate.
Short-term loans, sometimes known as bridge loans, usually have a repayment term of 12 months or less and may be a good option for purchasing a rental property quickly before seeking a traditional bank loan. Medium-term business loans typically have terms ranging from 1 to 5 years, while long-term business loans may have terms of up to 25 years.
3. Business line of credit
A business line of credit is similar to a home equity line of credit (HELOC), except that the loan is for a business. A company can draw on the credit line as needed and only pay interest on the amount of funds borrowed. The credit line is replenished as the loan is paid back, and funds are available to borrow again.
Lines of credit may be secured by assets the business owns or unsecured with no collateral backing the loan. Interest rates and fees are generally lower with a secured business line of credit. However, if the loan is not repaid, the lender may take the collateral used to secure the loan.
4. Alternative business loans
Alternative business loan options include invoice financing and invoice factoring.
Invoice financing is used to borrow money against the value of unpaid customer invoices. The lender collects a percentage of the invoice value as a fee, and as customers pay their invoices, the business pays back the loan.
Invoice factoring works similarly, except that outstanding invoices are sold to the lender for a percentage of the total amount owed. The lender is responsible for collecting payments from the customers, and customer payments are sent to the borrower, less the lender’s fee.
5. Private money lender
Private lenders are investors and investment groups that are alternatives to traditional business lenders.
Qualifying for a business loan and receiving funding from a private lender may be faster, although they typically come with higher interest rates and fees than other business loan options. However, a private lender may be able to structure a business loan for rental property to better meet the needs of both the borrower and the lender.
One of the challenges in working with a private lender is that they can be challenging to find since they generally don’t advertise the way traditional lenders do. However, a good private money lender can usually be located by asking fellow real estate investors and your contacts, including property managers, title company agents, and insurance brokers.
6. Portfolio lender
As the name implies, a portfolio lender keeps the loan in its own balance sheet or loan portfolio rather than selling the loan on the secondary market. Because of this, loan terms and conditions can be structured to meet a borrower's needs, and loan approval and funding may also be faster.
Because portfolio lenders hold the loan, they can develop their own underwriting guidelines instead of following federal lending guidelines. As a rule of thumb, when underwriting a portfolio loan, the lender places more emphasis on the cash flows and property types being financed versus a borrower’s credit score or business assets.
Portfolio loan options vary from one lender to the next and typically include loans with fixed and adjustable-rate permanent financing, short-term bridge loans, and business lines of credit. Provided a borrower can repay the loan, there are generally no limits to the number of rental properties a business can finance.
As with private money loans, portfolio loan interest rates and fees are typically higher than traditional forms of financing. They may also be nonrecourse, so they do not require a business guarantee or a borrower's personal guarantee.
7. Blanket mortgage
A blanket mortgage allows a business entity to finance multiple rental properties under a single loan rather than holding individual mortgages for each property. Generally speaking, the underlying assets serve as collateral to secure the loan, making blanket mortgages a popular option for real estate developers and businesses buying multiple rental properties.
Blanket mortgage loans typically have a release clause that allows individual properties to be sold without refinancing the entire loan. However, a borrower who wishes to refinance may have the option of refinancing the whole loan.
Obtaining a blanket mortgage can be a convenient option for a business because loan underwriting and funding usually take less time, and there is only one monthly mortgage check to process. On the other hand, defaulting on a blanket mortgage can put all properties at risk of being foreclosed on, and loan fees and interest rates may also be higher than traditional mortgage financing.
Can SBA loans be used for rental property?
The SBA offers 2 small-business loan programs for businesses purchasing real estate, SBA 504 and SBA 7(a). However, neither can be used for speculation or investment in rental real estate nor to purchase property held for investment purposes.
An SBA 504 loan is designed for businesses with a net worth of less than $15 million and provides long-term, fixed-rate financing for a company to purchase major fixed assets that promote business growth and job creation. For example, a 504 loan can be used by a business to buy or construct an owner-occupied building or improve an existing facility.
The SBA 7(a) loan program provides short- and long-term working capital for small-business owners and is the best option when real estate is part of a business purchase, according to the SBA. The maximum loan amount is $5 million. Primary uses for funds include purchasing real estate, building or renovating an existing building, acquiring a new business, or expanding an existing business.
Final thoughts
Business loans for rental property are found through various sources, including traditional, private, and portfolio lenders. There are options for acquiring new rental property, renovating existing rentals, and expanding a real estate investment portfolio. As with any other type of financing, a business owner should take the time to analyze the pros and cons of each loan option and seek the advice of a certified public accountant (CPA) or financial advisor.
