What are Commercial Mortgages
Simply put, commercial mortgages are loans taken out by businesses. These loans can be used for 3 main purposes. Firstly, you want to buy business premises or set up a business. Secondly, if you want to buy an already existing business. And finally, if you want to raise capital on a business you already own.
When compared to unsecured business loans, which are often capped at £25,000, commercial mortgages often offer much larger amounts. This is because they are secured, either against a property you already own, or the property you’re purchasing. In some cases they can be secured against the value of the business, its stock or its assets.
Typically, commercial mortgage terms are around 15 to 25 years. However, they can be as short as 3 years, and stretch all the way up to 40 years. Over the course of the term it is also possible to get the mortgage on either a repayment or interest only offer.
Types of commercial mortgages
There are three main types of commercial mortgages.
- The first is an owner-occupied mortgage. This is when a business is buying a property for them to trade out of.
- The second kind is a commercial investment mortgage. This mortgage is when a business is buying a property as an investment opportunity. An example of this is buying the property to then let it out to a third party, which would be seen as a commercial investment property.
- The third is semi commercial – where the property has both a commercial and a residential element
There is almost an infinite number of permutations of property types, business types and borrower types. Once you factor in affordability, credit profile, experience, age and other similar factors, it’s easy to see why help from an expert who knows the market is so important.
With residential mortgages , lenders tend to look at facts. Commercial mortgage are different and lenders also look at the borrowers back story and future plans. Do they like your business model and are they willing to support you. The skill of a commercial mortgage brokers is not just knowing which lenders. It’s also important to know how to best present your application.
Are you eligible
Your ability to get a commercial mortgage will primarily be affected by the businesses ability to keep up with repayments. So not only do you have to be confident that your business can do this, but you have to prove it to lenders. This will include presenting a viable business plan to the lenders, as well as valuations on the property.
As well as this, there are all the standard criteria that lenders expect you to fulfill. These can include credit history, though while most lenders prefer clean credit, there are lenders willing to consider poor credit loans.
Another key aspect lenders look for is suitable security for the loan. In most cases the property the money is being borrowed for will be sufficient, but sometimes lenders require more security alongside.
With owner-occupied mortgages, lenders normally require at least 2 years of proof of income. While there are lenders willing to work around this, rates could be less favourable.
Generally, it shouldn’t be too hard to find a lender willing to offer commercial mortgages provided you can demonstrate you can afford the repayments and are not trying to borrow at a high loan to value. However, finding the best rates for your circumstances can be much more difficult. If you are not sure how best to progress, get in touch with an adviser who can help find the best deal for you.
Different types of lenders
Tier 1 lenders
These tend to be the high street lenders and main banks. They normally offer lower rates and charges. Their criteria is more strict and they will require you to evidence a higher disposable income that other lenders.
They look for stability, don’t like a poor credit history and can be fussy about the type of business or property involved.
We always start by considering the tier 1 lenders and can quickly work out if your business or property is likely to be of interest to them.
Tier 2 lenders
These lenders are more flexible when considering affordability, credit and property type. In fact nearly every aspect of the application is more relaxed and they are more likely to offer interest only facilities to help keep the repayments low.
However they are accepting a higher risk profile thanthe Tier 1 lenders and consequently their rates are likely to be higher by 1% to 2%.
Tier 3 lenders
There are some very good Tier 3 lenders around and they will accept even more risk.
However, care must be taken – especially if you approach a lender direct. Commercial lending is an unregulated market and some of the documents are not as clear as they could be. Some products can have a sting in the tail particularly if you settle early.
Apply via an FCA authorised broker who has a duty of care to explain these points to you.
An unregulated lender can just give you the paperwork and often they use asset finance type agreements which could result in you being seriously mislead about the early settlement costs and rates offered.
Rental income – investment property
Many lenders judge a commercial investment on how much income it is predicted to generate. Some lenders will expect a property to generate a rental coverage of 190% for commercial properties. Rental coverage is when lenders take the monthly repayments of the mortgage, and then multiply it by a certain amount, which is the threshold for the income the property must generate.
For example, the repayments for a commercial mortgage are £1,000 a month. The lender then expects a rental cover of 190%. For the property to meet this requirement, it must generate £1,900 a month.
As you might expect the Tier 1 lenders will require a higher rental coverage than tier 2 / 3 lenders
Business income / profit – owner occupied property
Where you are securing the mortgage on a property from which you run your business, the lender will consider the ability of the business to afford the repayments. They will apply a similar income coverage calculation to assess affordability.
As a general rule, owner occupied businesses are more attractive to the Tier 1 lenders. As a result they are likely to be offered lower rates and higher loan to value ratios than an equivalent rental investment property.
The strength of your business accounts is vital and Tier 1 lenders tend to ignore any external income; for example you own another business and want to use its profits to prop up the mortgage.
They will base their assessment on the EBITDA of your business. EBITDA means Earnings before Interest, Taxes, Depreciation, and Amortization. This ignores the influence of non-operating factors such as interest expenses, taxes, or intangible assets Therefore the calculation gives the lender a more accurate indication of the operational profitability of the business.
Adding back to improve your profits
When calculation profit for lending purposes, EBITDA allows us to add back tax and depreciation to arrive at a higher profit figure. This helps attract more Tier 1 lenders.
In addition to this, if you are remortgaging an existing loan, we would add back the current mortgage payments to increase the profits. Similarly, if you are buying a property you currently rent, we would add the rent back to your profit to increase the serviceability of the mortgage. After all you wont be paying rent any longer once the mortgage completes.
Dividends. We said earlier that Tier 1 lenders will only look at the profit from the business occupying the building. However, if you have taken significant dividends from the business, we may be able to add some of these back. This will support a higher EBITDA and show more profit. In turns it helps justify larger lending amounts. To do this we need to show that the excess dividends were more of a bonus, and not required to support your normal living / household costs.
Note – Tier 2 and 3 lenders are far more flexible and some will consider using external income and interest only repayments to help make the mortgage affordable.
What Loan to value can you borrow?
The amount you could borrow depends primarily on the type of property offered as security and the business type.
If you are trying to get finance for an owner-occupied property, then you could find lenders offering up to 75% LTV. However it will depend on the sector and how strong the lender perceives that sector is.
To give an extreme example, during the COVID pandemic, lenders were quite enthusiastic about convenience stores and take aways. This is because they remained open and traded well. 75% LTV was available even during the pandemic. On the other hand offices and general retail suffered so LTV’s were reduced. Some lenders wouldn’t fund them at all.
Similarly, commercial investment property was affected in the same way. Some lenders stopped funding the sector entirely. Others cherry picked residential investment accommodation but wouldn’t touch retail or offices.
As a rule, if you are an owner occupier, don’t expect to borrow more than 75% LTV. So a 25% deposit will be required. To attract more lenders and get significantly better terms work on 65% LTV and a deposit of 35%
As an owner of investment property expect to be offered 5% to 10% lower LTV’s depending on the property.
If you are short on security its always worth considering what additional security you can offer a lender. It could be a legal charge secured on other property you own, assets or a debenture over another business. Discuss it with your broker.
If you own a building and your business trades from it, there will often be a goodwill element to the value of your business.
The building is worth simply the value of the bricks and mortar – what someone would pay for it if it was empty
However, your business may have a less tangible value. This could include the value of stock. It might be something less definite such as the brand, reputation, customer base, technology. More importantly the ability of the business to make future profits.
The key point here is that some lenders won’t lend against the goodwill. Only the bricks and mortar value of the building. Those that will need to split the value of the building so it is separate to the goodwill.
This is particularly important where you are buying a business.
How much of the purchase price is attributable to the bricks and mortar value of the building. How much is attributable to the goodwill.
At some point the property will be valued at a significant cost to you. This is often well in to the application process. This is wasted time and money if the valuer confirms a split between the property value and goodwill which is different to what you expected.
You could get a valuation at an early stage from a valuer which is accepted on most lenders panels. However this too could be an abortive cost if the loan subsequently fails for another reason relating to income etc.
Ask lots of questions of the selling agent and the vendor and discuss it with your broker about the best way to proceed.
Problems getting a commercial mortgage
While there can be many problems getting a commercial mortgage, there are also many specialist lenders who can help.
One example of this is if you are struggling with bad credit. While high street lenders will not give you much consideration, an adviser could be able to put you in touch with a specialist lender for your circumstances. There are lenders who could consider someone with no credit history, poor credit, miss payments and more. However, these lenders may require extra security in order to offset the risk. To find out if you could get a commercial mortgage the best course of action is to get in touch with an adviser.
What fees are involved
There are a variety of fees that could be involved. The first you would come across is the lender arrangement fee. Typically this is between 1%-2% of the loan value, but with smaller loans this percentage can increase. These fees are usually added on the completion of the loan.
Some lenders and brokers also require commitment fees. These are fees that some lenders charge to cover the costs of the work they do, regardless of whether you accept the offer. Normally these fees are paid at the start of the application, and are non-refundable. There may be a completion fee instead which is paid after the mortgage completes.
Another fee that will be charged is a valuation fee. This fee is a requirement for your application, and it will allow the lender to properly value the property. These valuations are normally much more thorough than those in the residential sector. The price of valuation can vary greatly between different properties, so you will not know the cost until you are progressing with your application.
You will also have to pay both the lenders legal fees and your own. These fees are also dependant on your own individual application.
You should consider
It is tricky to navigate through the commercial mortgage market. This is where a broker will be especially helpful. Not only will a broker have knowledge of the sector, but they will also have contacts too that could help with your application. Through these contacts a broker could find you an offer that you could not normally find by yourself.
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