How to finance a commercial property investment

Financing a commercial property purchase can feel like a daunting process for both new and sophisticated investors, and it is easy to be overwhelmed.

Here is a guide that answers some of the key questions facing commercial property investors when applying for a loan.

What will you need to show a bank when applying for a commercial property loan?

Mortgage Choice chief executive officer Susan Mitchell said it was imperative commercial property investors made an informed decision when seeking a loan.

“The key consideration when lenders assess this type of loan application is whether or not the property will be able to generate a rental income from tenants as this will be a key component in determining the value of the property,” she said.

Some of the basic things you need to have approved to get a commercial property loan are:

– details of any existing lease, including the length of the lease agreement
– if the property does not have a tenant, you need to demonstrate how you will afford to maintain the property and make repayments
– your income details, including the rental income from the property
– your deposit and equity from other properties, if any
– details of the property itself, including the asset class (i.e. office, warehouse, shop), location and valuation.

Paul Cleary, director of Melbourne-based specialist broker Synergy Commercial Property Finance, added that investors would need to show details of their financial situation in the past two to three years and their trust deed if their company is set up as a trust business structure.

How much can you borrow when buying a commercial property?

Ms Mitchell said investors buying commercial property could not borrow as much as those buying residential properties.

“Unlike residential property where you can borrow as much as 95 per cent of the property’s value, most lenders require borrowers to have a minimum contribution of 30 per cent when applying for a commercial loan. In other words, the lender will consider lending up to 70 per cent of the property’s value,” she said.

Mr Cleary said the specific amount an investor can borrow often depends on the property price.

“For sub-$1 million acquisitions, this can be up to 80 per cent of the purchase price or valuation, but for anything over $1 million, this is normally set at 65-75 per cent of the purchase price and is usually restricted or set by the servicing calculation set by the bank,” he said.

Buyers of commercial property also cannot access lender’s mortgage insurance, so it is essential to have a sufficient deposit or equity to qualify for the loan.

However, there is a good chance of scoring approval if you are buying a traditional commercial property (for example, an office) with a stable tenant that will be in the space for another few years.

What to consider before applying for a loan

A mortgage broker who specialises in commercial property loans can tell you precisely what you need to know before making an application.

They will also have the right relationships with key lenders and can recommend lenders according to your situation, as they will know the ins and outs of each lender’s different criteria and loan options.

“Given that the process differs substantially from a traditional residential mortgage, it is always best to speak to a broker first and foremost to confirm indicative rates and terms and leverage,” Mr Cleary said, adding that this should be done when first looking at a property.

A specialist broker will also be able to help you negotiate the terms of the loan, especially on bigger loans.

And as commercial property loans are so complex, having legal and financial experts on your side is also essential to comb through the terms of the contracts and lease agreements, Mr Cleary said. Clauses that could affect the underlying property value include termination or break clauses that allow the tenant to end the lease earlier than agreed.

“Unless you are a very sophisticated borrower, there is far too much risk involved to proceed with this type of loan without considering all the consequences,” Ms Mitchell said.

“Consult your accountant, solicitor, a mortgage broker experienced in commercial loan deals and financial advisor before making any decisions.”

How is commercial property lending different to residential?

As commercial properties are more susceptible to slumps in the economy, lenders generally consider these to be a higher-risk investment than residential.

While lenders for residential property loans are fairly transparent with their interest rates and often have carded rates, this is not the case for commercial property loans, for which rates are not always publicised.

In fact, terms on the commercial property loan can almost always be negotiated.

“Commercial loans are more complex and are generally priced on risk, which means that the more risk you present to the lender, the higher your interest rate will be,” Ms Mitchell said.

“Several factors will determine risk, such as [the] location of the property and demand for the type of property – often the more specialised the property, the lower the demand.”

For instance, assets including offices and warehouses are seen as “standard commercial properties” because they appeal to a larger pool of tenants, while spaces built for a specific purpose such as hotels and service stations are seen as riskier as potential tenants and buyers are limited only to businesses in that sector.

Commercial property loans also have much shorter loan terms of between two and 15 years, compared with the 30-year terms of residential property loans.

Despite all the differences, buying commercial and residential property is virtually the same in one aspect: the settlement process.

Common misconceptions and pitfalls surrounding commercial property loans 

Mr Cleary said many people incorrectly believe that commercial property interest rates are similar to residential rates.

“At present, you are able to achieve a rate of say 3.6 to 3.7 per cent for an interest-only (residential property) investment loan at 80 per cent [loan-to-value ratio], however, in commercial loan land this would be a rate of 4.5 to 7 per cent with gearing of 65-80 per cent,” he said.

Mr Cleary noted that another common misconception is that surrounding loan set-up fees, which are usually higher than residential property loans, as borrowers need to pay for:

– commercial valuations, which are generally higher than residential valuations, due to their complexity. They also need to be paid upfront.

– lender legal costs, which covers the lender’s costs of preparing legal documents and services, and

– lender application fees, which are negotiated and are tailored to each deal.

As a guide, the fees can range from 0.5 per cent to more than 1 per cent of the loan amount.

“It’s always best to consult a professional who has expertise with commercial property and commercial loans as these differ immensely to residential and could result in a costly error if you obtain incorrect advice,” Mr Cleary said.

Another area to be wary of is vacant commercial properties.