How commercial property loans work

How commercial property loans work

October 25, 2019

I recently covered a blog on my conveyancing page about 'How does commercial property investment work?' where I discussed how commercial property loans can ask for high upfront deposits depending on the perceived property risk. I thought I would go into commercial property loans a little more because there are several factors you want to be ready for if you apply for a loan on a commercial property. Even if you have previously applied for residential properties and know the system, you may still be caught out with some of the additional requirements commercial property loans can throw at you.

Of course, we wish it were possible to pay for that commercial investment in full and not even have to worry about a loan, but the reality for thousands of Australian small business owners who want to buy instead of rent their business premises is that a business loan is a necessity.

Commercial loans usually attract additional administration and handling fees that are not part of residential loans, this is normally due to the time and labour for due diligence a bank will carry out to investigate your loan strength.

You can also expect the valuation of your commercial property to be more expensive than having your home valued as there are a larger number of risks to take into account and lease and contract terms to consider.

How much you can borrow and what you'll pay are determined by their own unique rule set.

Borrowing restriction

The amount you can borrow will depend a little on the property type and potential profit, however, even if your portfolio is solid, your upfront cash input is high, you won't be able to borrow the same amount for commercial property as you can for a home loan.

Typically, a small commercial property loan that is $1M or under you will able to borrow a maximum of 80% of the property price, especially if it is a single-security deal.

Once you get over $1M then the borrowing amount will drop to around 75% for low risk and 70% as a maximum loan amount for most properties. Why the added upfront payment? Commercial property is a higher risk, if your business fails, so do your repayments. Banks and lenders need to feel confident with the risk reduction at their end and need you to prove you have access to funds and commitment to see it through.

On the plus side, you will pay less on interest and pay your loan off faster.

Loan periods

Commercial lending periods are shorter than residential. Businesses typically look to repay their loans much faster. A loan period will typically fall somewhere between 15 and 20 years. The most you can hope for on a $1M or less loan is a 20-year term.

If your loan amount is larger than $1M then you can generally expect a three-year term, but that can be an interest-only term, rather than the full amortised amount.

Higher fees

The riskier your business or property is considered to be the higher your interest rate, which is not good news when you factor in that interest rates are already set at a higher price than home loans. What it typically translates to is that this particular lender is not especially keen on this loan type. It's worth shopping around and doing your research to find lenders that regularly back your kind of business.

If your loan is strong and your business is small you can look for better deals, with rates as low as 3% in some cases.

Variable prices

Unlike home loan rates which you can choose off the shelf, commercial loans will take the results of their assessment of you into account. After checking over a base range of criteria they will determine the interest rate they feel is the best match for your purchase.

Criteria include the business risk, gearing level, type of business, popularity of the product, and even the property location.

To calculate how likely you are to repay your loan your lender will estimate the surplus income after expenses have been paid and compare this to the debt repayments for the loan.

You will never be asked to cover the lender's mortgage insurance.

While many of the rules and conditions of commercial property loans end up costing you money, here is one place where you save. You will not be asked to cover the lender's mortgage insurance as it doesn't exist for commercial properties.

Regular reviews

Your bank will want to keep an eye on things, especially if you have a larger loan. With home loans as long as you are making your repayments on time the bank is satisfied with your ability to continue. For larger commercial investment loans you will need to provide your lender with regular access to your financial details so they can ensure you are in a good financial position, even if all your repayments have been on time and accurate. These can be yearly reviews, business activity statements (BAS) or even quarterly reviews

Due to the added risk and complexity of commercial property investment purchases, you will see differences in the way your commercial loan is handled and priced. Rather than be caught off guard when you apply for your loan do some research to know what the average prices and terms are for your particular property. Talk to other property owners, sit with different lenders and talk about your options so you can make an informed and professional decision that will help your investment going forward.

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