types of commercial loans

October 22, 2021

John Maher talks with Mike Luster, Executive VP and Commercial Loan Officer, and Andrew Marques, Commercial Loan Officer, from Cape Ann Savings Bank about commercial loans. They cover different types of commercial loans such as installment loans, real estate loans, lines of credit, bridge loans, and more, and they explain how businesses use these loans.

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Transcription Disclosure: Below is a transcript of the conversation between John Maher, Mike Luster and Andrew Marques. Please note, this is an unedited "word for word" rendition of the actual conversation and is not intended to be grammatically correct.

John Maher:  Hi, I'm John Maher. I'm here today with Mike Luster, Executive VP and Commercial Loan Officer, and Andrew Marques, Commercial Loan Officer, at Cape Ann Savings Bank. And today we're talking about the types of commercial loans. Mike and Andrew, welcome.

Mike Luster: Thanks John. We appreciate you having us to do this and we're looking forward to a great conversation.

Andrew Marques: Hey, John. How are you?

What Types of Commercial Loans Are Available?

John Maher: Great. Can you guys tell me a little bit about what the various types of commercial loans are that are available?

Mike Luster: Sure. The ones we see most often are commercial installment loans for equipment purchases or something like that. Commercial term loans, business lines of credit, commercial real estate loans, and commercial construction loans are the more popular ones we say on a daily, monthly, yearly basis.

How Do Commercial Mortgages Work?

John Maher: And in terms of a mortgage or a commercial real estate loan or commercial mortgage, can you tell me a little bit more about those and how that works?

Mike Luster: Sure. A commercial real estate loan is used when someone wants to buy either a commercial building or a mixed-use building. They're also used to buy multi-family properties. You can purchase a one-to-four family building using a typical residential loan in some instances, but anything with five or more units, John, would need a commercial loan. So you're looking at five or more residential units, a commercial property, or a mixed-use property. Would you like to talk a little bit about a mixed use property?

Mixed-Use Properties

Andrew Marques: We're fortunate in Cape Ann to have a lot of unique properties and really in Massachusetts itself. A mixed-use property has a commercial aspect to it, whether it's a retail store on the first floor, or maybe some office space, but it also has a residential unit or multiple residential units. There's different pockets, especially in Cape Ann which is a popular tourist destination, and it has a lot of retail spaces on the first floor of those buildings and it has condos or apartments upstairs.

John Maher: Right. In Gloucester, in particular and Rockport, you see a lot of that type of loan happening.

Andrew Marques: Yeah. That's pretty common. And that's the nice thing about working with the local bank. We really know different neighborhoods and the areas and the types of properties and the value that they have and the appeal that they can have to investors.

Mike Luster: They're actually pretty common all over Cape Ann on the north shore. If you look at the revitalization in downtown Beverly, downtown Salem, any downtown area, the city is going to have retail or commercial space on the first floor and they're really promoting downtown living. It's somewhat simpler to permit downtown residential living on second and third floors now. It's really been part of the revitalization of some of these downtown areas.

What Are Term or Installment Loans?

John Maher: Mike, you talked about installment and term loans. Can you talk about those and what the differences are?

Mike Luster: Sure. Commercial installment loan, typically used when you're purchasing a piece of equipment. You'll see a lot of machine shops that need lays, drill presses, dye cutters, or anything like that. They're also used for the purchase of a business, whether it's a transaction involving an outside party coming in to buy the business. Let's say a longtime restaurant owner wants to sell the business. A commercial installment loan is used to buy the business.

They're also used for inter-family transactions. When people are setting up succession planning, a family member wants to sell it to another family member. There's usually some type of financing needed. And that's also what a commercial installment loan is used for. Equipment, vehicles, anything like that, even inventory in some cases. And in some cases, like I said, it's even the purchase of a business.

What Are Construction Loans?

John Maher: Can you talk a little bit about construction loans and how that works. If a business wants to buy a piece of property maybe, and then build a building, what is a construction loan and how does it differ from other types of commercial loans?

Andrew Marques: A construction loan is typically real estate based. It deals with collateral and property. And depending on the property itself, we can either rehab it with construction funding, or it can be ground up construction for a new manufacturing facility, a new multi-family building, or a new condo development, or simply a development of single-family homes. Construction loans can vary depending on the project, but generally they have a set period of time where it's interest only.

You draw available funds on the loan until the work is done, and then it would roll over into a permanent loan again, depending on the project itself. We can also do short term speculative construction loans where a property is purchased, either a property is rehabbed or built there, and then it can be sold on speculation once that is done on an open market transaction.

Types of Construction Loans

Mike Luster: There are two types of construction loans. Like Andrew said, one would be a business owner, possibly wanting to build a manufacturing facility. One might be a property owner looking to build an apartment complex to rent, but then he talked about speculative construction. One is more of a long-term construction loan and the other one is a short-term construction loan. The short-term construction loan, like Andrew said, would be based on a speculative purchase at the end. A contractor comes in, buys a piece of property, permits it for let's say four condominium units and then wants to sell them to end buyers where the end buyer will apply for their own mortgage to buy it from our contractor. That's more of a short-term investment in a speculative nature, and that would require a short-term financing vehicle.

What Is a Business Line of Credit?

John Maher: Can you tell me a little bit about a business line of credit and how that differs from a mortgage or something?

Andrew Marques: A business line of credit is used for short-term working capital. This would be money that's needed in a business's ordinary business cycle. I like to use a manufacturer as an example. They buy raw material, they need to transfer that raw material into works in process. They hire machinery, they have workers and laborers to get the material into their final product. And as that process is happening, there's expenses where they could draw on a line of credit as they're incurring those expenses and then pay it off once they recognize the income and the cash from those operations.

We can also do a seasonal line of credit for businesses that have a really busy season and then maybe a down season, they need working capital to get going. We often see this in retail spaces or restaurants that open for a part of the year and they can draw on those funds, pay for start-up inventory for the season, and then pay it down as they have cash coming into the business through their busy season.

What Is an Interest-Only Loan With a Balloon?

John Maher: There are a couple of other types of commercial loans that I've heard of. And I want to get your opinion on them. And maybe tell me a little bit more about what they are. There's an interest only payment loan, or what might be called a balloon loan. What is that?

Mike Luster: Most of the times you see a balloon note or an interest-only loan is what I was just suggesting in the form of a speculative construction loan. That is a short-term credit facility where someone's using it for a specific purpose. They're going to pay it off with the sale of maybe real estate. They pay interest only for whatever the term may be. There might be a fee involved with that as well, on the financing, because it is such a short-term loan.

Typically when we use interest only financing is when there's a specified purpose that is going to have an end result of a sale of an asset to pay off the loan, and then they move onto the next project.

John Maher: Okay. So that might be for like the construction, like you said, of a new building or something like that, or a new housing complex where they're going to use that loan to buy the land, build the building, and then once it's built sell it,

Mike Luster: Sell it off piece by piece.

John Maher: And then they're gone and they're off to the next project.

Mike Luster: Correct. And years ago when some of the smaller banks started getting into the commercial lending area, a typical commercial real estate loan would be for five years, but the length of the loan would be longer to stretch out the payments, but there would be a balloon note due at the end of five years. They found themselves refinancing that maybe three, four, or five, six times until the loan was paid off. But now most of the banks do adjustable rate notes so that they just convert at the end of the five-year period, the interest rate would convert to whatever the market rate was at the time, but years ago, you're right, they used to be done on a balloon note, and that would force people to get new appraisals, new legal fees every three or four years. That has changed a little bit in the industry where for the most part, the balloon notes are tied to construction loans at this point.

What is a Commercial Bridge Loan?

John Maher: Okay. And then another one that I've heard of is a commercial bridge loan. Is that similar to what we're talking about? Or is that something a little different?

Andrew Marques: It is similar. Bridge loans are typically tied to one time contracts or transfers of properties. We can do a bridge loan if someone was selling a property, buying a new one, and as it suggests, it bridges the funding gap between those purchases and the sale. It's typically looked at on a case by case basis. Whether we do a short term loan or a bridge loan, there's different aspects that we would look at in terms of any project, and the nice part about commercial lending is we have the ability to structure a loan that really meets the borrower's needs.

Mike Luster: I think that's important what Andrew just said, John… When it comes to community business lending and community lending, we don't have any cookie cutter products that are advertised on a rate sheet. We try to meet with the customer, whatever their needs are and try to, sometimes it's fitting a square peg into a round hole. There are times when it's pretty vanilla, but there are other times where we just try to match the needs of the bank with the needs of the customer. And that's what it's about.

It's interesting that Andrew just mentioned that because it's not always a defined product that we fit people into. We like to meet with the customer first and then see what their needs are and see if we can put a package together that works for both parties.

What Is an SBA Loan?

John Maher: Right. Absolutely. And then the final type of commercial loan that I've heard of is the SBA loan. What does SBA stand for and what is an SBA loan?

Andrew Marques: The SBA is the Small Business Administration. It's an administration under the federal government and they provide guarantees to the banks to make loans that may be considered more risky. We see this often with startup businesses, young businesses, or businesses that have been operating in a smaller capacity and they're looking to expand potentially aggressively, or just more than what they've been doing historically.

We utilize the SBA programs for small businesses and startup businesses to provide usually term loans for startup working capital, inventory purchases, or equipment. It's ultimately a program that helps banks make inherently risky loans that they may not be willing to take on in their typical risk appetite. We're a certified SBA lender. We have delegated authority under their express program, which is one of the many programs that they offer. And we also have the ability to make SBA 7(a) loans.

SBA also has a separate loan program called the 504 program where the bank would work with a third party lender certified by the SBA. And we all go in on a project together. They fund a portion of it. We fund a portion of it, and there's certain benefits to help the borrower through lower down payments than would typically be required, more favorable, longer rates, longer fixed interest rates, and certain uses qualify for that. There's different rules and different structures to each program. And the nice thing is that the SBA is always updating their programs. Post COVID, they've done a lot of great adjustments to their existing programs. They've added new programs to help get capital to businesses that need it. And so the SBA basically provides guarantees to help banks make loans.

Small Business Lending in Massachusetts

John Maher: And like you said, Gloucester and Rockport have a really vibrant downtown area. I had imagined that you'd probably see a lot of those types of small businesses looking for an SBA type of loan in those towns.

Mike Luster: We don't have the luxury of having a lot of manufacturing in our town. We do a lot of hospitality based businesses, tourism, restaurants, those types of businesses. There are times when a business changes hands, there's new ownership and the SBA is needed. Sometimes there's a smaller manufacturer or a small company that wants to purchase their building, but they don't have the capital necessary to do it because they're still in their infancy stages and they're growing. But the SBA has come in with this program that Andrew talked about, which allows for a 10% down payment. And it really helps grow that business and keeps them headquartered in Gloucester or whatever town that they're doing the loan in. And it's really helped in a lot of situations and circumstances.

Andrew Marques: And we don't have a definite footprint within the SBA program. We've utilized the SBA program to make loans, to start up businesses off of Cape Ann outside of our direct lending area. That also helps mitigate the bank's risk in terms of not knowing the immediate area, maybe not being as familiar with the downtown and foot traffic, different aspects that you might consider in any underwriting. So it's not always limited to just Cape Ann communities. We've also done SBA lending and traditional bank lending in all sorts of towns in Essex County, in the North Shore.

Contact Cape Ann Savings Bank to Talk About Commercial Lending

John Maher: All right. Well, that's really great information. Mike and Andrew, thanks again for speaking with me today.

Mike Luster: Thank you, John.

Andrew Marques: Yeah. Thanks for having us. John: And for more information on commercial lending, visit the website at capeannsavings.bank.

Cape Ann Savings Bank, member FDIC, member DIF, equal housing lender.