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Commercial Property Loans
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A commercial property loan finances the purchase of property that is used for business purposes.
Business purposes can include anything from general office or retail space, warehouses and factories, to income producing farms, restaurants or even car parks.
As part of our service of finding and helping you apply for the right loan, we take the time to understand your goals and work with you to develop a strategy to help achieve them.
In this article, we’ll explain the key things you need to know about commercial property loans.
Why invest in commercial property?
Commercial property loans can be used to finance the purchase or improvement of an existing commercial property or the construction of a new asset (for example, a new building).
Commercial property versus residential property investment
If you want to invest in property, you generally have two options – residential or commercial. Most people focus on residential because that’s the most obvious of the two. We all have at least a basic understanding of the residential market because we all have a home that we own, are paying off, or are renting.
Commercial property on the other hand is less familiar to many people. There are both pros and cons of investing in commercial property compared to residential.
- Price: Commercial properties are generally cheaper than similar-sized residential properties.
- Longer Leases: Commercial leases usually run for much longer than a typical six or twelve- month residential property lease. Rental yields for commercial properties are usually also linked to the CPI (consumer price index) to protect the property owner against inflation.
- The tenant (lessee) usually pays for repairs, maintenance and rates: This is the opposite of a residential investment property scenario where these expenses erode the owner’s rental yield.
- The rental return (yield) is usually higher. This is to compensate for the generally higher risk of commercial properties for the owner.
- Potentially longer tenant vacancies: Although commercial property leases tend to be longer, it’s generally harder to find tenants than it is for a residence. It can be especially difficult if the commercial premises are large or have a very specific purpose. It can take months or even years to find a tenant in those situations. Commercial property loans therefore tend to be viewed as a higher risk by lenders.
- Commercial property values tend to grow more slowly and can even drop sharply: Several uncontrollable factors can have a significant impact on both the value of a commercial property and the rent that you can potentially charge a tenant when it’s time for a new lease to be negotiated. For example, changes in economic conditions, infrastructure, population demographics or the number of other commercial properties in the area can all have an effect. By comparison, the value and rental yields in the residential property market are generally more stable. To reflect this greater risk, the maximum loan-to-value (LVR) ratio (i.e. the maximum amount that a lender will be prepared to loan in relation to the value of the property) is usually lower for commercial property than it is for residential lending.
- You’ll pay GST on the purchase price: The 10% GST applies on the purchase of commercial property, but it doesn’t on residential property. However, the GST can be claimed back as an input credit on the GST component of the commercial property’s rental income, reducing the income tax payable.
Commercial property loans
It’s usually difficult to find and compare commercial property loan information on different lender’s websites. That’s because key information like interest rates and other important terms and conditions for commercial property loans are often negotiable. They depend on factors such as the type of business that requires the loan, the type of commercial property being bought and its location.
Commercial property loan purpose and risk
The purpose of a commercial loan affects the lender’s risk assessment of an application. Different commercial properties loans represent different levels of risk. Lenders will assess the details of the loan’s purpose as being low, medium or high-risk. Factors that they will consider in making this assessment include:
- Whether you are buying the property for investment purposes (for example, to lease to a tenant).
- Whether it will be owner-occupied (for example, if you are buying a retail shop to be used by your own business).
- Whether the commercial property’s purpose is standard or specialised. The more specialised the purpose of your commercial loan, the higher the risk to the lender. If you default on your repayments, it will be harder for them to resell the property to recoup your outstanding debt. They will usually require you to have a higher deposit accordingly. Standard properties on the other hand have broader appeal (i.e. they are easier to sell or rent out to a tenant) and therefore they have less risk.
We go through a number of frequently asked questions about commercial property loans below. If you have any further queries or would like assistance in organising a loan for a commercial property, please get in touch for an obligation-free conversation about your needs.
How do I prove my income for a commercial property loan?
There are a variety of ways you can prove your income for a commercial property loan, including:
- Full Documentation. This is where you provide standard proof of income documentation as part of your application, such as tax returns, pay slips, or business financial statements prepared by your accountant.
- Lease Documentation. If you’re planning to lease your commercial property to a tenant, your lease documentation can be used to show that their lease payments will fully (or significantly) cover your future loan repayments.
- Low documentation. This can include your bank or BAS statements, business financial forecasts, and/or a letter from your accountant to verify your capacity to make loan repayments.
- No documentation. Some specialist lenders may be prepared to provide you with a commercial property loan with no documentation. But they will charge you higher interest rates and potentially additional fees to compensate for the increased risk.
The more documentation you can provide to demonstrate that your commercial property loan will be low-risk for the lender, the more you will be able to negotiate the loan’s terms, conditions, fees, and interest rates.
What are the typical features of a commercial property loan?
The features of a commercial property loan depend on:
- Whether the interest rate is fixed or variable. Interest rates can generally be fixed for up to 5 years, but you can’t make additional repayments on fixed interest loans like you can with variable rate loans.
- Whether the repayments are for principal and interest, or interest-only. The standard commercial loan term is 15 years for a principal and interest loan, and 5 years for an interest-only loan. However, you can negotiate for longer periods (especially if you have residential property as security against the loan).
- The lender and the type of loan. You might be able to negotiate additional features. For example, a redraw facility (to enable you to withdraw any additional repayments you make later, if necessary), a line of credit (allowing you to borrow more funds up to a pre-set limit), or perhaps even an offset account to reduce your interest. But you will usually be charged either a higher interest rate or additional fees for these features.
What is a general security arrangement?
When you apply for a commercial property loan, lenders will sometimes require you to provide residential property as collateral security. This means that they may be able to repossess your home and sell it to recoup any outstanding debt, if you default on your repayments.
In addition, lenders might also ask you to sign a general security agreement, which provides the commercial property and/or your business assets as additional security. However, this shouldn’t be necessary if your residential security is sufficient to cover the loan.
Do I need to switch my business banking to get a commercial property loan?
If you apply for a commercial property loan with a different lender to the one you do your business banking with, most will require you to switch all your business accounts to them as part of the approval process. It increases their business and allows them to have a more complete picture of your financial affairs.
However, if switching banks is a hassle you’d like to avoid, you might be able to keep your business banking with your current bank, if you have residential property as collateral security and it covers your entire commercial property loan.
The commercial property loan application process
Because of their generally higher risk, commercial property loan applications have stricter criteria for approval. For example, in addition to collateral security, you might need to provide:
- A higher deposit. Different lenders will have different maximum LVRs that they’ll be prepared to accept. Each lender may also have different LVRs for different types of commercial properties. The higher the ratio, the more risk to the lender. A higher deposit lowers this ratio and therefore the lender’s risk. Depending on the lender and the type of commercial property loan, deposits of 20% or more of the purchase price may be required.
- A guarantor (i.e. an individual or an entity that contractually agrees to be responsible for your commercial property loan debt if you default on your repayments).
How do I get the best possible commercial property loan deal?
There are three important things you need to do:
- Apply to the right lender. Different lenders specialise in different types of commercial property finance. It’s important to choose a lender who has experience with the type of commercial property you’re investing in and has a good reputation. You’ll be more likely to have your loan application approved and have less hassle if you do this.
- Have a strong application. Provide as much evidence as you can to demonstrate you are a low-risk borrower and that your commercial property investment is attractive.
- Be prepared to negotiate with the lender. For larger commercial loans (e.g. over $1 million), your negotiating power increases if you have a strong application.
What else should I consider when taking out a commercial property loan?
Your commercial property should be in a high traffic area to attract plenty of customers for you or your tenant. It should also be accessible to public transport and surrounded by other complementary businesses. This will help your property to both retain its value over time as well as generate a relatively secure income.
What are annual reviews of commercial property loans, and do they matter?
Commercial property loans that lenders classify as higher risk or and/or that are for large amounts will sometimes be subject to an annual review. As part of this process, the lender will require you to provide your latest financial statements and business forecasts. They might also take the opportunity to re-value your commercial property if market conditions have changed.
This evaluation might place you in a higher risk category, enabling your lender to increase the loan’s interest rate or change other terms and conditions (for example, impose additional fees). It’s therefore important that you present this annual review information as comprehensively and accurately as possible so that your risk profile isn’t adversely affected.
But if your circumstances have improved, you can take the opportunity to potentially negotiate a lower risk profile to improve your loan’s terms and conditions.
How can a mortgage broker get you a better commercial loan?
There are many more considerations when applying for a commercial property loan than there are for most other types of finance. You need to do your homework and research the market before making any decision. But because commercial loan terms and conditions are negotiable, lenders don’t make that information readily available to allow you to compare their offerings.
Mortgage brokers like us regularly deal with commercial property loans from a wide variety of lenders. Accordingly, we are well informed about the commercial property loan market, including the lending criteria of different institutions and how far they may be prepared to negotiate.
We can help you find the best commercial property loan for your needs by taking the time to understand your situation. This includes liaising with your accountant and/or solicitor so their advice is taken on board. We can then help you to choose the right lender, as well as prepare and submit your application. Finally, we can negotiate the best possible commercial property loan deal on your behalf.
Contact us today to discuss your finance needs.
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