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How to finance a commercial property investment

  • July 01 2020
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Invest

How to finance a commercial property investment

By Zarah Mae Torrazo
July 01 2020

Financing a commercial investment property purchase can be a complex and difficult process. Here is our guide on how to finance this asset. 

How to finance a commercial property investment

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  • July 01 2020
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Investors looking to make it big in real estate tend to favour commercial properties over residential properties due to the former’s numerous advantages. Commercial investing is considered to be more attractive for those who are seeking promises of higher returns, security from long-term leases, a more stable monthly rental income and other benefits.

 But there are investors who are sceptic of commercial real estate investing due to its complex nature and perceived higher risk. Some investors can’t even overcome the first hurdle of financing a commercial property investment. 

Financing a commercial investment property purchase can be intimidating for both new and seasoned investors, who can easily find themselves overwhelmed with the process. 

Here is a guide that answers some of the important questions facing commercial property investors.

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What is a commercial real estate loan?

Commercial real estate loans are used to buy or renovate a commercial property. For this type of loan, the main consideration when lenders assess the application is whether a property will be able to generate a rental income from tenants. 

Banks are generally willing to lend up to 60-70 per cent of a commercial property’s value. This  loan-to-value ratio (LVR) is because most lenders require borrowers to put down a minimum deposit of 30 per cent when applying for a commercial loan. This is contrary to buying a residential  property, where you can borrow as much as 95 per cent of the property’s value. 

If you are already a property owner, you can also use the equity in your existing house for a commercial real estate loan. 

 Like residential property loans, you can choose from a variable, fixed or a split interest rate, or making principal and interest or interest-only repayments. Each lender offers a commercial property loan with features, products and pricing that are made for their target market, so do your research to find a lender that will fit your needs. If you are unsure how to tackle this task, you can hire a commercial mortgage broker to get you matched with a suitable lender. 

 How much can you borrow for your commercial real estate purchase? 

The specific amount an investor can borrow depends on the commercial property price. 

If you have a guarantor to secure your loan, you can borrow up to 100 per cent of the property value. If you are going to buy a commercial real estate with a price tag of up to $1 million, you can borrow up to 80 per cent of the property value. 

For any property that is above $1 million, it averages at 65-75 per cent of the purchase price. For loans that are between $5 million to $50 million, the application is assessed on a case-by-case basis and is usually restricted or set by the serving calculation set by the bank you are applying to. 

What type of properties can I buy?

Standard commercial properties are usually the best type of security for a commercial property loan, as it is viewed to have a wide market, which means that you have more potential tenants and buyers. This includes offices and warehouses. Banks are also willing to offer higher LVRs and lower interest rates for these types of properties.

Purpose-built properties such as pubs or aged care facilities are designed for a specific industry or commercial use. This means it will only attract business people operating in that particular space. The high fluctuation of vacancy rates for purpose-built properties also poses a risk to lenders. 

Specialised properties will require a detailed valuation and risk assessment from the lender. You are usually required to put down a sizeable deposit to get your loan approved.

How can I get my commercial property loan approved?

Commercial investment property loans are different to standard residential investment loans. The pricing and lending policies for commercial property mortgages (unlike that of residential loans) are flexible and many of the terms can be negotiated. 

If you put down a big deposit or if you can acquire the property sufficiently, they will not require you to submit as much financial information such as payslips or financial statements. 

While this is good news if you are self-employed or you are working in the gig economy without a regular income, it also poses a risk. You will have less options as a borrower if you are approved for a commercial investment loan and you cannot make repayments on time. This is because commercial investment loans are not regulated by the National Consumer Credit Protection Act. Buyers of commercial property also cannot access lender’s mortgage insurance, so it is important to have a sufficient deposit or equity to qualify for the loan.

But, as mentioned, not everything is set in stone with commercial mortgages. For example, there is a good chance of getting approved for a loan if you are buying a traditional commercial property (e.g. offices, warehouses and factories) with a stable tenant that will be in the space for a few more years.  

 What are the basic requirements I need to have my loan approved? 

Given that there are less laws and regulations regarding commercial property loans, banks have more freedom with their lending policies. They are not required by law to have proof that a borrower can afford a loan. This caused the industry to create its own guidelines to verify that a borrower can make repayments. 

Proof of income verification

Here are some of the income verification options offered by banks: 

Full doc: This is a standard loan application where you provide complete financial statements.  
Lease doc: With this option, you must provide proof that the potential income from the lease is bigger than the interest repayments.
Low doc: Partial income evidence is required by the letter, including bank statement or Business Activity Statements.
No doc: You will not need to provide evidence that you can afford a loan. This option applies for certain cases. Non-bank and specialist commercial funders may consider a higher risk application such as a no-doc loan.

Security property and general security agreement

The major difference between commercial lending and regular home lending is the security property involved. Since there are no programs providing lender’s insurance to cover borrower default, they must rely on the real property pledged as security. The security property will be used by the lender as protection in the event you can’t repay the debt.

The value of the security is assessed by a professional valuer. This is called a bank valuation. A bank valuation will determine the approximate price of the property and will be used to calculate the loan size and the LVR. This also gives the lender an indicative price on how much they can get for the asset if they have to sell it.

 After providing collateral, most banks will also require a general security agreement (GSA) over the property and all of your business assets. But if you can afford the loan or you have enough equity, your mortgage broker can argue on your behalf against a GSA Guarantee and Indemnity.

Tips for getting a commercial property loan approved

Each commercial property loan application and security property attached to it is unique. This means that there is no standard way how lenders assess commercial property loans. To help you get started, here are some tips to getting your property loan approved. 

Choose the right lender for you

Choose a lender that specialises in the type of finance that you are looking for. Are you a start-up business? Are you a low-risk or highly geared commercial property investor? Or are you representing a corporate entity or a self-managed super fund looking to buy a property? By choosing a lender that has more knowledge and experience lending to people with your specific needs, there is a higher chance that your commercial property loan will be approved.

 Step up your application  

Don’t be complacent when filing your application. It’s rather easy to just fill in the application and give the documents they are asking from you. But if you want a sureball approval (with good terms and interest rates), present a strong case why you need to be approved. Present your current situation the way your bank prefers to receive it. For example, if you know that the bank you are applying in wants to see as much information as possible, make sure you can provide all that you can give them. On one hand, if a lender is more inclined towards a bare minimum application, you can also customize your application.

Negotiation is key 

You’ve just received word that your application hit a snag and the bank can’t continue to process it. Don’t lose hope! The next step is to negotiate it and see if you can resolve any issue. 

If they have concerns regarding your application, provide any additional information to mitigate their concerns. You can also change your situation (if possible) to better match their lending guidelines. 

Sometimes an application can be too risky for a bank and will result in your loan getting rejected. It may be because you are a new borrower or they are not comfortable with the size of your loan. In this case, you can negotiate the pricing to match the perceived risk. Lowering your LVR would lower the risk to the bank and enable them to consider your application.

Conclusion 

Financing a commercial investment property can be intimidating due to its complex nature. By answering some of the basic questions about this process, it will be easier for you to decide on your next step to ensure that you can secure a loan to purchase commercial real estate.

If you are unsure whether you should go straight to a bank or seek the advice of a mortgage broker regarding your commercial investment property loan, read here

How to finance a commercial property investment
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