Executing a commercial rental property loan contract is a huge undertaking for any investor or business. The choices you make at this point can affect your business flexibility, long-term success, and financial well-being. Commercial loan contracts are complicated, full of jargon and complexities different from those of residential loans. In the fast-paced, changing real estate environment today, knowing the legal environment and the right questions to ask before you sign is more crucial than ever.
According to recent industry data, the U.S. commercial real estate loan market will surpass $5 trillion in outstanding debt by the end of 2024; that’s how big and how much is at stake. With interest rates fluctuating and lenders getting more stringent, it’s important to be informed and cautious. Whether you’re an experienced landlord or a first-time investor, this guide will walk you through six questions to ask before signing any commercial rental property loan agreement so you can be set up for success and protected from costly surprises. Commercial loan transactions have become more complicated.
1. What Are the Key Terms and Obligations in the Loan Agreement?
Before you sign, review every clause in the loan agreement. Commercial loan contracts have terms that dictate your repayment schedule, interest rates, prepayment penalties and default consequences. Unlike residential loans, commercial loans have shorter terms (5-20 years) and may have a large balloon payment at the end. Did you know that 20% of all commercial and multifamily mortgage balances, almost $957 billion, are maturing in 2025? That’s why it’s important to understand maturity dates and refinancing options.
Key points to clarify:
- Interest rate type (fixed or variable) and how it can change over time.
- Repayment schedule and amortization period.
- Prepayment penalties or fees for early repayment.
- Events that constitute default and the lender’s remedies.
- Personal guarantees or collateral requirements.
Tip: Ask your lender for a summary sheet of the main financial and legal obligations. Don’t hesitate to consult a real estate attorney to explain any unclear terms.
2. Who Is Legally Responsible for Repayment, and What Guarantees Are Required?
Commercial loans are issued to business entities, not individuals. However, lenders often require personal guarantees from business owners, which makes them personally liable if the business defaults. Questions to ask:
- Is there a personal guarantee required, and what are the implications?
- Co-signers or additional guarantors?
- What if the business structure changes (e.g. new partners or owners)?
Know your liability. A personal guarantee can put your assets at risk. Ask both your lender and attorney.
3. What Are the Loan-to-Value (LTV) and Debt-Service Coverage Ratio (DSCR) Requirements?
Lenders use LTV and DSCR to determine risk and eligibility. Commercial loans usually require a lower LTV (65–80%), so you’ll need a bigger down payment than residential loans.
- LTV: Percentage of the property’s value financed by the loan. Lower LTV means more equity from you.
- DSCR: Net operating income of the property against debt obligations. Most lenders require a DSCR of 1.25.
Tip: Be prepared to show the property’s income potential and your business’s financial strength. This will help you negotiate better terms and avoid surprises during underwriting.
4. What Are the Costs Beyond the Loan Principal and Interest?
Commercial loan agreements have many fees and costs. These can add up and should be included in your budget. With commercial/multifamily borrowing and lending projected to rise 16% to $583 billion in 2025, lenders may be more strict on terms. Recent Federal Reserve rate cuts have brought down borrowing costs, and borrowers and lenders are optimistic. Common costs are:
- Origination fees (0.5–1% of the loan amount)
- Closing costs (3–4% of the loan amount), for appraisals, legal fees, inspections and title insurance
- Ongoing administrative or servicing fees
- Prepayment penalties
Note: Always ask for a full breakdown of all fees and charges before signing. Compare offers from multiple lenders to make sure you’re getting competitive rates and reasonable costs.
5. What Happens in the Event of Default or Early Repayment?
Defaulting on a commercial loan can be serious, such as foreclosure, loss of investment, or damage to your credit. You should know:
- What constitutes a default (missed payments, breach of covenants, insolvency, etc.)
- Lender’s process for default
- Timeline and options to cure default
- Penalties for early payment or refinancing
Some commercial loan agreements have “acceleration clauses” where the lender can call the entire loan due immediately if you default. Others have prepayment penalties if you pay off the loan early. While refinancing opportunities should get better with stable or lower rates, delinquency rates, especially in the office sector, are still high. Office loan delinquency rates were above 9% in late 2024.
Tip: Negotiate these terms where you can and have an exit strategy in place before signing.
6. Are There Any Restrictions on Property Use, Leasing, or Transfer?
Commercial loan agreements often have restrictions on how you can use, lease or transfer the property. These covenants are for the lender’s benefit but can limit your flexibility as an owner. Key restrictions to look for:
- Subleasing or assigning the lease to another tenant
- Occupancy or income requirements
- Property modifications or renovations
- Selling or transferring ownership of the property
Note: If your business model relies on subleasing or future resale, make sure the loan agreement allows for this without excessive penalties or hurdles.
Additional Considerations
Besides the loan agreement itself, there are other important things to consider. Ignore these, and you’ll have problems down the line. So before you sign, take a minute to think about these, too, which will give you a full picture of your responsibilities and risks.
- Legal Compliance: Commercial tenants don’t have the same consumer protections as residential tenants. It’s a good idea to consult with a real estate attorney before signing any agreement, especially for long-term or high-value deals.
- Insurance Requirements: Most lenders require comprehensive property insurance. Confirm what types and amounts of coverage are needed.
- Documentation: Have all necessary documents ready, including business tax returns, financial statements, property appraisals and proof of insurance.
Conclusion
Securing a commercial loan for a rental property is a big commitment that requires legal and financial due diligence. By asking these 6 questions before signing any agreement, you’ll be better protected, avoid hidden traps, and set yourself up for long-term success. Remember, the right preparation and professional advice can make all the difference in commercial property finance. For more info on securing a commercial loan for your rental property, check out reputable resources and consider professional legal and financial advice.
