The basics of a commercial property loan
Commercial property investment can be a lucrative endeavour, with long-term tenants paying solid rents and delivering a big, often double-digit, yield.
When it’s good, it’s a great vehicle for your money that delivers long-term cash flow and the potential for capital growth.
But when it’s not good, it can be a money pit.
Commercial leasing markets are notoriously unpredictable, with the potential for fluctuating levels of demand, long periods of vacancy, flippant tenants as well as high risk.
That’s why banks and other lenders treat commercial lending very differently to residential mortgages.
The stakes are higher and so the playing field is unique.
A snapshot overview
Commercial property loans allow business owners and prospective investors to purchase a premise.
Lenders are open to applications for a broad range of properties, including factories, office spaces, large-scale storage sheds, warehouses, shopping centres, industrial facilities, accommodation, restaurants and pubs and retail stores.
If you’re looking to buy a commercial property with the view of leasing it out to a tenant, you will likely rank a little lower on the risk scale than someone buying a premise to run their own business out of.
But either way, commercial lending is riskier than residential lending, and so banks treat the process very differently.
The maximum loan-to-value ratio will differ from lender to lender and will often depend on individual circumstances.
Rates are often higher and can vary between lenders.
Loan limits can also be more stringent and the higher the amount, the more conditions imposed.
Different from a home loan
Those taking out a loan for commercial property for the first time might have a lot of ideas about how it works based on their experiences with residential mortgages.
But as you can probably already tell, you might as well throw almost all of that prior knowledge out the window because there aren’t many similarities.
For one, lenders’ mortgage insurance doesn’t exist.
An LMI policy allows home loan borrowers without the full 20 per cent deposit to still get a mortgage – conditions and approvals pending, of course.
LMI covers the bank against defaults and gives them some piece of mind when assessing mortgage candidates who are seeking to borrow more than 80 per cent of the home’s value.
But there’s no such luxury when it comes to loans for commercial real estate.
And the maximum LVR is typically 65-70 per cent or lower.
The life of the loan is also shorter with commercial properties.
Whereas you might expect to take out a 30-year mortgage for your family home or investment property, it’ll be at least half of that for a commercial loan.
And unlike residential loans, merely making your repayments on time and not being a bother isn’t always enough to keep the bank happy.
If you’re taking out a large commercial loan, expect your lender to regularly ask to review your financials.
Prices are higher
The size of the loan will often impact the relationship with your lender.
If you’re taking out a relatively modest loan for a standard commercial premise, like a shop or small office, then you’ll jump through fewer hurdles and pay less.
But if it’s a bit outside the box and a larger loan, you’ll probably pay more and hear from your bank manager a lot.
The interest rate payable can also vary significantly depending on a range of factors.
Home loan rates are normally pretty static, with difference between fixed and non-fixed periods.
But not so in commercial lending.
Rates will be determined by the location of the property, its purpose, the security used to secure the loan and the rental or business income.
Interest rates are also higher than for residential property, given the additional level of risk involved for the bank.
But, again, it depends on the individual property.
If it’s a shop in a good suburb with low commercial vacancy rates and a solid tenant, it could be a reasonable figure.
If it’s a riskier enterprise, such as a hotel or a little boutique in a quiet outer suburb, the rate will likely be higher.
Package and service fees tend to be a bit heftier, too.
It’s a different borrower market with very different considerations, and the profit margins for lenders can be slimmer and less reliable than in the residential game.
Your tenant matters
Let’s say you’re looking to buy a light industrial shed facility as an investment.
It’s in a good location, it’s well-maintained and the rental income is strong.
A lender will look at much more than that – including who has leased the premises and the strength of their operation.
Commercial vacancy rates can fluctuate pretty wildly over a short period of time.
The leasing market is much more volatile than the housing market, and it’s driven by a large number of variables.
The economy, interest rates, global markets, import and expert trends, and employment rates all combine to determine the strength of a sector.
Let’s say the tenant in that property you’re looking at is a printing business that produces phone books.
I dare say the bank might be uncomfortable with the security of the operation and its ability to keep paying that healthy rent amount in the long-term.
That’s why commercial property loans are more tricky than residential ones, but they’re not something that need to be feared as long as you have the right support every step of the way.
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