What is a Commercial Mortgage?
If you’re looking to expand your business or the cost of renting commercial premises has become too great, you may be considering investing in a property. Chances are, you’ll be investigating the range of commercial mortgage options on offer as a potential source of business finance and you’ll quickly discover that there’s a lot to bear in mind.
What do you need to think about?
With a commercial mortgage, you won’t experience sudden or large rent increases, but remember, monthly repayments could go up if you have a variable rate deal. You may, however, be able to get a fixed-rate mortgage for a period of time.
If the property increases in value, your business capital will go up and interest repayments on a commercial mortgage are tax-deductible. You could potentially rent a portion of the premises to another company to help meet those monthly repayments if your lender allows such an arrangement.
Repayment options are not unlike those found in the residential market, but there’s usually a slightly higher rate of interest, as commercial mortgages are perceived as higher-risk. It’s sensible to be able to minimise this risk with as large a deposit as possible – at least 25%.
And as well as the usual valuation, arrangement, and legal fees, there can be additional costs associated with a commercial mortgage, so it’s worth seeking clarification from a lender or your broker.
There are a plethora of commercial mortgage providers out there, from the main high street banks to specialist lenders, so it’s worth searching the market or speaking with your commercial finance broker to find one that ticks all your boxes — for the most commercially viable option.
What kind of mortgage is available?
In general commercial mortgages can be used for three purposes:
Commercial mortgages for owner-occupiers are usually for two commercial reasons: either a business wants to purchase the premises where it currently operates, or it wants to buy new premises to move into.
B. Residential buy-to-let
Another scenario for commercial mortgages is the purchase of residential property to be let out. This area is commonly used by professional landlords with a property portfolio, as well as buy-to-let limited companies set up for the same purpose.
C. Commercial buy-to-let
You can use commercial mortgages for commercial buy-to-lets as well. For example, you might want to purchase a warehouse via your company and let it out to another business. This type of mortgage is similar to residential buy-to-let, the lender may look at different factors because typically, it’s more difficult to rent out commercial properties. Sometimes you may hear the term OPCO/PROPCO. An operating company/property company deal (OPCO/PROPCO) is a strategy in which a company is divided into at least two parts: a property company that owns all the real estate and/or assets, and an operating company that uses the property and/or assets to generate sales.
Who provides commercial mortgages?
There is a large number of lenders offering commercial mortgages, each with their own benefits and limitations.
The main perk of the major banks is that if you’re eligible, their rates are going to be hard to beat. They’ll often lend against the OMV (Open Market Value) and offer quite high LTV (Loan To Value), which means you may get a larger mortgage, and the main banks are also more likely to have shorter and less arduous tie-in periods.
One of the cons is that their criteria can be more difficult to satisfy. They require a fairly high DSCR (Debt Service Coverage Ratio), which will require a higher income to service the same amount of debt than you would with alternative lenders, and if you have recent credit issues they’ll often turn down your application outright. In general, the process of applying for a commercial mortgage can take a long time with the major banks, with decisions regularly taking more than 3 months.
Challenger banks generally have a greater appetite for business and can help some of the businesses that high-street banks can’t. To start with, their DSCR requirements are usually lower, which means their income threshold for commercial mortgages can be easier to satisfy. They will also consider applications with credit issues in the last two years, which the high-street won’t usually do.
Challengers sometimes offer interest-only repayment options up to the maximum LTV, which makes sense for businesses who buy their premises for cashflow reasons rather than capital gains — for example where the interest-only payment would be less than their current rental payments.
The cons; challengers come down to cost and flexibility — typically, they cost more than the major banks, and will often have higher exit fees for the term of the mortgage, which may reduce your choices if your future is uncertain.
Challengers may also agree on the commercial mortgage amount based on a 180-day marketing period (or a RICS Red Book or RICS certified valuation) rather than the OMV, which can potentially lower the amount you can borrow.
The Niche & Spealsists
Comparedthe previously stated types of lenders, the smaller specialist lenders are a lot more flexible overall. If you want a commercial mortgage but haven’t been in business long, the niche lenders may be your best choice, because they are often prepared to lend to shorter trading histories and have lower affordability criteria (DSCR). In some cases, it’s even possible to use future cash flow forecasts/projections instead of trading history if they’ve been signed off by an accountant.
The specialist lenders may also be more flexible in terms of location, considering applications in most areas of the UK . These situations will be looked at on a case-by-case basis.
As you might expect, the downside of these types of lenders is the cost — they’re more expensive commercial mortgages than those you’ll get from the banks. The smaller lenders tend to lend against the FSV (Forced Sale Value) too, which is usually lower than OMV and therefore can massively reduce the percentage of the property value you can borrow.
They’ll have longer terms, and more restrictive exit fees. For example, you may have a minimum period of 8 years on a 10-year mortgage with exit fees ranging from 2–7% — definitely more restrictive than the banks. With that in mind, if your situation means you’re only eligible for the specialist or niche lenders, then comparing with high-street or challenger banks is irrelevant.
Do I qualify?
Your business’ trading history will be relevant here.
When it comes to getting a commercial mortgage, your trading history is relevant. Lenders need to know that your business can afford the mortgage and will be able to service it. If you operate a limited company that’s currently trading, you’ll need at least 3 years of full filed accounts (including notes and detailed P&L) to be eligible for the high-street banks, and at least 2 years of accounts for the challengers.
If you’re wanting to buy a property to start a business, you’ll need to have a compelling lump sum to put in yourself. Loan-to-value ratios for a brand new business with no trading history will vary but typically will be in the region of 50% of the purchase price, so to purchase a property worth £200,000 you’d need a minimum of £100,000.
Professional landlords looking to get commercial mortgages for residential rental property, you’ll need to demonstrate previous experience in this area, some lenders will only class a landlord as a professional landlord once you hit a certain number of rental properties.
What the property is used for can be critical, not all commercial mortgages are the same, and what the property is used for makes a difference to both the interest rate you’ll pay, and how much borrowing is available.
Owner-occupied businesses such as offices or shops can in some cases get a maximum loan-to-value of around 80%. But, if you decide you want to split your office building into smaller units and rent these out, then that’s a different proposition. Now you have gone from an owner-occupied business to a commercial buy-to-let business, and your maximum LTV drops to 75%. Guess what, your interest rate goes up too.
Where the property is located can also be a factor in organising a commercial mortgage. If your business already owns properties in the same area of the country, getting a new commercial mortgage might be difficult for the banks because you’ve reached what they call the ‘concentration limit’ which can be very common for professional landlords. This is a risk management issue, the idea being if the market in that area drops, then you’re much more exposed than you would be with a portfolio of properties spread all over the country.
What will I need to offer as security? Surely the lender will have the property so nothing else is needed?
Lenders will require some form of security when offering commercial mortgages — it provides a contribution to help offset their risk when providing large mortgages for offices, warehouses or other commercial premises. The following should help you to understand what is needed in terms of security and alleviate any concerns.
1. Is there equity in your offered security?
The truth is it’s not just a simple case of using your property or asset’s market value as a guide to what you can borrow. The more accurate measurement is to use the remaining equity in the property. Lenders base their assesment on different valuations – sometimes, the forced sale value – and they take into account any outstanding debt against the security. In most cases, you will need to have remaining equity of at least 75% of the value of the property you are looking to buy.
2. Is your deposuit big enough?
Lenders can ask for additional security to help you purchase the property. It is often the case that a lot of your cash is tied up in business operations or existing property, so providing additional security can be a good option for those businesses that find themselves asset-rich but cash-poor.
3. The plethora of lenders means the security requirements are vast!
This is a key point that many prospective buyers don’t fully appreciate, and it is a major reason for using Finance for Entrepreneurs or other similar services. To secure mortgages (typically large ones), different lenders will only accept certain types of assets. As an example, some lenders prefer taking second charges, rather than the first charge, against property. Others prefer to take specific types of property as collateral, like residential properties, pubs or warehouses. They even have different preferences when it comes to using sites and land as security, and the location of the asset can sometimes be vital.
4. Don’t overlook the fees!
You will also have to include extra fees such as the valuation fee when using security in any funds lent — this is on top of the usual legal and arrangement fees. Finance for Entrepreneurs will clarify what you should expect in terms of fees as the process nears completion and, we also have access to a select number of partners which in some instances may be cheaper.
Commercial finance brokers & intermediaries like Finance for Entrepreneurs are here to assist you on your journey to securing a commercial mortgage. Here are five ways we can help:
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