If you are a business owner or an entrepreneur looking to expand your operations or invest in new opportunities, borrowing money on a commercial property can be a viable option.
Commercial property loans are designed to provide financing for purchasing, refinancing, or renovating commercial real estate, such as office buildings, retail spaces, warehouses, and industrial properties.
Commercial property loans are typically larger and more complex than residential mortgages, and the lending criteria and terms may vary depending on the lender, the property type, and the borrower’s financial situation.
Therefore, it’s important to understand the basics of borrowing money on a commercial property before applying for a loan.
Can I borrow money on a commercial property?
Yes, it is possible to borrow money on a commercial property. Commercial properties, such as office buildings, retail spaces, and warehouses, can be used as collateral to secure loans from financial institutions, private lenders, or other lending sources.
The loan amount and terms will depend on a variety of factors, including the value of the property, the borrower’s creditworthiness, the purpose of the loan, and the lender’s requirements.
Generally, lenders will consider the property’s income potential, location, and condition when determining the loan amount and interest rate.
Commercial property loans typically have higher interest rates and require larger down payments than residential property loans. Additionally, the loan terms are usually shorter, often ranging from 5 to 20 years.
It’s important to research and compare lenders to find the best terms and rates for your specific situation and to ensure that you can meet the loan requirements and repayment obligations.
Types Loans you can borrow on a commercial property
Commercial properties are properties that are meant to generate income, such as office buildings, retail stores, and warehouses.
If you own or are interested in purchasing a commercial property, you may need to borrow money to finance your investment. Here are the different types of loans you can borrow on a commercial property:
- Traditional commercial mortgage loan
This is a loan that is used to purchase or refinance a commercial property. The loan is secured by the property, and the interest rate and terms are based on the borrower’s creditworthiness, the property’s value, and the loan amount.
These loans are typically offered by banks, credit unions, and other traditional lenders.
- Small Business Administration (SBA) loan
The SBA provides loans to small businesses, including those that own or want to purchase commercial property.
The SBA has several loan programs, including the 7(a) loan program, which can be used to finance real estate purchases, and the 504 loan program, which can be used to purchase, construct, or renovate commercial real estate.
SBA loans typically have lower interest rates and longer repayment terms than traditional commercial mortgage loans.
- Bridge loan
A bridge loan is a short-term loan that is used to finance the purchase or renovation of a commercial property while the borrower waits for longer-term financing.
Bridging loans are typically offered by private lenders and have higher interest rates and fees than traditional commercial mortgage loans.
- Mezzanine loan
A mezzanine loan is a type of financing that combines debt and equity. Mezzanine lenders provide financing to borrowers based on the borrower’s equity in the property, rather than the property’s value.
Mezzanine loans typically have higher interest rates than traditional commercial mortgage loans and are used to fund the gap between the borrower’s equity and the amount of financing they need.
- Commercial construction loan
A commercial construction loan is used to finance the construction of a new commercial property.
The loan is typically structured to provide funds to the borrower in stages, as construction progresses.
The interest rate on a commercial construction loan is typically higher than on a traditional commercial mortgage loan.
- Hard money loan
A hard money loan is a type of loan that is secured by the commercial property. These loans are typically offered by private lenders and have higher interest rates and fees than traditional commercial mortgage loans.
Hard money loans are often used by borrowers who cannot obtain financing from traditional lenders due to poor credit or insufficient collateral.
Qualification to borrow money on a commercial property
When it comes to borrowing money for a commercial property, there are several qualifications that potential borrowers must meet.
These qualifications vary depending on the lender and the type of loan being sought, but there are some general requirements that most lenders look for.
Credit Score
One of the most important qualifications for borrowing money on a commercial property is a good credit score.
Lenders will review the borrower’s credit history and credit score to assess their creditworthiness.
A higher credit score indicates that the borrower is more likely to repay the loan, and as a result, they may be offered more favorable loan terms, such as a lower interest rate.
Debt-to-Income Ratio
Another important qualification for borrowing money on a commercial property is the borrower’s debt-to-income (DTI) ratio.
The DTI ratio measures the borrower’s monthly debt payments as a percentage of their gross monthly income.
Lenders want to see a low DTI ratio, typically no more than 43%, which indicates that the borrower has enough income to cover their debts and the new loan payments.
Income and Assets
Lenders will also look at the borrower’s income and assets to determine their ability to repay the loan.
In addition to the borrower’s regular income, lenders may consider rental income from the commercial property, as well as other sources of income.
Lenders will also look at the borrower’s assets, including any cash reserves, stocks, and bonds, to assess their ability to make payments on the loan.
Property Value and Cash Flow
Another important consideration for lenders is the value of the commercial property and its potential cash flow.
Lenders will want to see that the property has a strong potential for rental income, which will help ensure that the borrower can make payments on the loan.
Lenders will also want to see that the property is appraised at or above the loan amount, which helps reduce the lender’s risk in case the borrower defaults on the loan.
Experience
Lenders may also consider the borrower’s experience in managing commercial properties. If the borrower has a proven track record of successfully managing similar properties, this can help reduce the lender’s risk and increase the likelihood of loan approval.
Conversely, if the borrower is new to managing commercial properties, they may be viewed as a higher risk.
Down Payment
Lenders may require borrowers to make a down payment on the commercial property, typically ranging from 10% to 30% of the purchase price.
This helps reduce the lender’s risk and ensures that the borrower has some equity in the property.
Loan-to-Value Ratio
The loan-to-value (LTV) ratio is the amount of the loan divided by the value of the commercial property.
Lenders typically require a maximum LTV ratio of 75% to 80%, meaning that the borrower must have enough equity in the property to cover the remaining 20% to 25% of the purchase price.
Business Plan
Borrowers may also be required to submit a business plan that outlines their plans for the commercial property, including how they plan to generate rental income, their marketing strategy, and their financial projections.
Lenders want to see that the borrower has a solid plan for the property and that they have the experience and skills necessary to make it a success.
Personal Guarantees
In some cases, lenders may require the borrower to provide a personal guarantee for the loan.
This means that the borrower is personally responsible for repaying the loan if the commercial property is unable to generate enough rental income to cover the loan payments.
Personal guarantees can help reduce the lender’s risk and increase the likelihood of loan approval.
Factors which determine how much you can borrow on a commercial property
When it comes to borrowing money to purchase a commercial property, several factors come into play.
Lenders are generally more cautious when it comes to commercial property loans than residential loans, and they will look at a range of factors to determine how much they are willing to lend.
Here are some of the key factors that lenders will consider when assessing how much you can borrow on a commercial property:
- Loan-to-Value Ratio (LVR)
The loan-to-value ratio is the amount of the loan compared to the value of the property. This ratio is an essential factor that lenders consider when assessing your loan application.
Generally, lenders will lend up to 70-80% of the property’s value for commercial loans. The higher the LVR, the more risk the lender is taking, so you may be required to pay a higher interest rate to compensate for the increased risk.
- Cash Flow
Cash flow is the amount of money generated by the property that can be used to service the loan. Lenders will assess the cash flow of the property to ensure that there is sufficient income to cover the loan repayments.
They will look at the rental income generated by the property, along with any other sources of income, such as car park revenue, to determine the property’s cash flow. The higher the cash flow, the more you may be able to borrow.
- Rental Yield
Rental yield is the amount of rental income generated by the property as a percentage of its value.
Lenders will look at the rental yield to determine the property’s income potential. Generally, the higher the rental yield, the more you may be able to borrow.
- Property Type
The type of commercial property you are purchasing can also affect how much you can borrow.
Lenders are generally more willing to lend on properties that are easier to sell, such as retail or office space.
Properties that are more specialized, such as manufacturing plants or warehouses, may be more difficult to sell, and therefore lenders may be less willing to lend on these types of properties.
- Location
Location is an essential factor when it comes to commercial property loans. Lenders will assess the property’s location to determine its potential for capital growth and rental income.
Properties in high-growth areas, such as those close to major transport links or in city centers, may be more valuable and generate more income. As a result, lenders may be more willing to lend on these types of properties.
- Borrower’s Financial Position
Lenders will consider the borrower’s financial position when assessing how much they are willing to lend.
They will look at your credit history, income, and expenses to determine your ability to service the loan.
If you have a strong financial position, you may be able to borrow more than someone who has a weaker financial position.
- Loan Term
The term loan is the length of time over which you will repay the loan. Lenders will assess the loan term to ensure that it is appropriate for the type of property and the borrower’s financial position.
Generally, longer loan terms will result in lower monthly repayments but higher total interest costs over the life of the loan. Conversely, shorter loan terms will result in higher monthly repayments but lower total interest costs.
- Loan Repayment Structure
Lenders may offer different loan repayment structures, such as interest-only or principal and interest repayments.
Interest-only repayments mean that you only pay the interest on the loan, while principal and interest repayments mean that you pay both the interest and a portion of the loan principal.
Lenders may offer different repayment structures depending on the borrower’s financial position and the type of property.
- Property Condition
The condition of the property can also affect how much you can borrow. Lenders may require a property inspection to assess its condition and ensure that it is suitable for the loan.
Properties in poor condition may be more difficult to sell or generate income, and as a result, lenders may be less willing to lend on these types of properties.
- Purpose of the Loan
Lenders will consider the purpose of the loan when assessing how much they are willing to lend.
If it is business loan for business expansion or improvement, lenders may be more willing to lend a larger amount as they see the potential for increased income.
However, if the loan is for a speculative investment or high-risk venture, lenders may be less willing to lend a large amount as there is a higher risk of default.
Conclusion
Borrowing money on a commercial property can be a complex process that requires careful evaluation of the property, the borrower’s financial situation, and the lender’s requirements.
Before applying for the commercial loan, it’s important to research different types of loans, compare rates and fees from multiple lenders, and prepare a comprehensive business plan
