The right commercial property can have the same, if not better, rental yields and capital returns than a residential property. However if you're just getting started with investing in commercial property, it might be a little daunting compared to investing in residential property given it's not as common. In particular, you might be unsure about how financing a commercial property investment differs to a regular mortgage. Perhaps you're wondering "What are the similarities and differences between residential and commercial loans?"
The Commercial Lending Process
The overall commercial lending process is the same as residential property lending when it comes to applying for a commercial property loan. Lenders will consider key criteria such as:
- Your capacity to repay – all of your income including expected rental income from the commercial property
- Your deposit and any available equity
- The type of commercial property – whether it's a factory, office, warehouse or shop-front and its location, together with a valuer’s report.
- Details of the commercial property lease and conditions.
5 Tips You Should Know Before Applying For a Commercial Property Loan
1. Specialised Commercial Lenders
First up, it’s important to know that whilst commercial loans may be less familiar to many people, there are actually a variety of loan options available from a range of specialised commercial lenders.
Mainstream lenders i.e. the Big 4 banks will tend to automatically move buyers of commercial property into their commercial lending products – this often means higher interest rates and more restrictive conditions than their regular residential lending.
However what many people don’t realise is that if they use a mortgage broker who understands commercial lending, they can often get access to second tier lenders which specialise in commercial lending.
9 out of 10 times these specialised lenders are more competitive. In fact we’ve seen some loans with the same or close to residential mortgage rates, and even with annual fees waived.
2. Lower Loan-To-Value Ratios on Commercial Loan = Larger Deposits
Whilst residential borrowers can borrow up to 90% (or even 95%) of the value of the property (LVR) - Commercial property loans are generally capped at 70% LVR. This means that you would generally either need a larger deposit or be able to access more equity.
3. Shorter Loan Terms
A typical residential property loan term is 30 years, whereas for commercial property it is generally between 15 to 20 years. The consequence of this is that borrowers will need to show a lender a greater capacity to repay, as the repayments will be higher as the principal will need to be paid down in a much shorter time frame, even if it is partly interest only. You need to show a stronger serviceability in regards to your pay slips, rental income on other properties and lease agreements, compared to the LVR you are planning to borrow and your other financial obligations.
4. Different Lease Terms
There is a variety of commercial lease terms and some leases can provide benefits and incentives that can enhance an applicant’s loan application, e.g. the length of lease and outgoings being paid by tenants.
Most residential leases last between 6 to 12 months. Commercial properties, on the other hand, are subject to longer term leases – ongoing 3+3 years or 5+5 years with options to extend for another 3 or 5 years. Tenants in commercial properties are also more likely to pay their own outgoings such as water, rates and land taxes. This can sometimes factor favourably into your loan application as it can evidence a greater ability to service the loan.
5. More Fees = More to Borrow
Commercial loans have higher valuation fees which usually need to be paid up front. Just like when you apply for a mortgage on a residential property, a lender will need to order a valuation when you apply for a commercial property loan. Whilst residential property valuations are generally done for free, most lenders will unfortunately pass on the cost of a commercial property valuation to you.
For commercial properties under $1 million, this can cost between $800 and $1,500. For properties over $1 million the fees will be higher and in addition professional valuers will typically charge you a much higher amount depending on the lender, location of property and type of property.
Depending also on yours and the vendor’s GST status, some sales of commercial property might attract an additional GST cost.
In summary, financing a commercial property isn’t much harder than applying for a regular mortgage, though keep in mind that:
- You will need to show a greater capacity to repay a commercial property loan given the shorter loan terms of between 15-20 years; and
- You will need a higher deposit/equity because you will generally only be able to borrow up to 70-80% of the value of the property.
- And of course, finding the right mortgage broker to give you more loan options can also make a very big difference.
About the Author
Neil Carstairs is the founder of Mortgage Corp, an active property investor and awarding winning MFAA accredited finance broker with more than 10 years of mortgage broking experience. Currently, Neil is one of only few MFAA Certified Mentors in VIC/TAS region. He is known for his strategic approach to investing and ability to reach fast, successful outcomes for clients where his industry peers could not.
Mortgage Corp specialises in helping current and future property investors maximise their loan serviceability, tax savings and long-term investment returns. Mortgage Corp takes a long-term, strategic approach to help their clients maximise their overall investment result. Mortgage Corp is known as the most loved mortgage broking firm in Melbourne with consistent 5 star customer reviews.