As you strive to expand your business, it is likely that owning the premises that houses your operation will become more of a priority vis-à-vis renting or leasing it. But of course, this is not exactly the most affordable endeavor – indeed, of all the major costs required to grow your business, acquiring a commercial property is sure to be among the most significant.
If you do not have the funds at your disposal to purchase the property outright, you will almost certainly be looking towards securing a mortgage facility to obtain the necessary funding. This is where a commercial mortgage can prove hugely useful. Whether you are looking to buy a property for your business, renovate an existing business property or develop land for commercial usage, a commercial mortgage can be the ideal funding option to pursue.
What is a Commercial Mortgage?
Also known as a business mortgage, a commercial mortgage is a popular form of business financing for purchasing commercial property and land. The property itself can be anything from a retail center to an office building. Even apartment complexes are permissible under certain types of commercial mortgage agreements.
As is the case with a residential mortgage, you borrow can borrow funds via a commercial mortgage agreement from a mortgage lender such as a bank, a credit union, an asset-backed trust (for commercial mortgage-backed securities) or a specialist lending firm. You then repay the loan in monthly installments at either a fixed or a variable interest rate.
Also much like a residential mortgage, a commercial mortgage is a secured form of business financing, such that the business property itself serves as collateral for the loan. This also means, however, that the property could be at risk should you fail to make loan repayments on time.
That said, not every aspect of a commercial mortgage is aligned with its residential sibling…
Key Differences Between Commercial and Residential Mortgages
Purpose – rather than borrowing money to acquire residential property, commercial mortgages are strictly designed for you to secure property for commercial purposes.
Approval Requirements – gaining approval for a commercial mortgage is more challenging – and takes much longer – than for a residential mortgage. With more due diligence on both yourself and your business by the lender, the loan approval process for a commercial mortgage can take as long as 4 months.
Property Value – given that the size of commercial land and/or property tends to be bigger than that of residential ones, so too are their respective values. As such, the loan amount issued via a commercial mortgage covers a typically higher range than that of residential mortgages.
Term – while residential mortgages commonly stretch out to 30 years, the term for a commercial mortgage will normally be shorter at around 5 to 20 years. Commercial mortgage lenders may also structure into the loan agreement a lump-sum “balloon payment” you must fulfill at the end of the term.
Deposit – lenders invariably require a much bigger deposit to obtain a commercial mortgage than they do for residential mortgages. This is reflective of the higher risk commercial properties pose to the lender, as the repayment is dependent on the success of your business which is far from guaranteed, as well as the changing market environment.
Commercial mortgage lenders are typically willing to loan you up to 85 percent of the value of the commercial property you want to buy (this is known as the loan-to-value ratio (LTV)). This means you must post a minimum 15 percent as a down payment at the start of the agreement.
Types of Commercial Mortgage
Owner-Occupied Commercial Mortgage – this type of mortgage is suitable if you aim to occupy the premises for the operation of your business. It may be the premises you are currently renting (a short-term tenancy) or leasing (longer-term tenancy), or an entirely new property located elsewhere.
If you are run a retail business, for example, you may want to stop renting your current property and buy it outright instead. In which case, an owner-occupied commercial mortgage is the most appropriate type of commercial mortgage for you.
Commercial Buy-To-Let Mortgage – are you looking to acquire a property for the main purpose of renting/leasing it out to an entirely separate business? If so, a commercial buy-to-let mortgage (also known as a “commercial investment mortgage”) is the most appropriate funding option.
Let’s say you are seeking to purchase a multistorey building within which you want lease out office space to various businesses, or you want to purchase a warehouse to be used by other companies. In both cases, a commercial buy-to-let mortgage will be the most useful.
Residential Buy-To-Let Mortgage – much the same as a commercial buy-to-let mortgage, the main difference being that the tenant is a private lessor / renter instead of a commercial business.
So, if you are a landlord seeking to purchase a building to turn it into an apartment complex, a residential buy-to-let mortgage will be a suitable form of financing.
Semi-Commercial Mortgage – this is used to buy a property for a mixture of both commercial and residential purposes.
If you operate a bar on the ground floor, with residential apartments located in the same building on the floors above, you would opt for a semi-commercial mortgage.
Applying for a Commercial Mortgage
1. Conduct Thorough Research - Obtaining a commercial mortgage can be a long process, with banks and other lenders taking as much as 4 months to approve and issue you with the financing. If you need quick funding, therefore, you may want to seek an alternative mechanism.
It also means that it makes sense to rigorously research the best available commercial mortgage for your business needs, especially given the sheer number of both commercial mortgage lenders and mortgage products on offer across the market. Once you have made a shortlist, it then becomes time to approach the relevant lenders to identify the mortgage products that are open to you.
2. Pre-Qualifying Assessment – Compared to other most other funding options, you will have to satisfy a more stringent criteria that lenders will use to decide whether you can proceed with a loan application, including a strong personal and/or business credit rating, and sound financial track record.
For example, commercial mortgages are generally issued if your business has at least 2 years of operational history to its name, as well as $250,000 in annual revenue as a minimum. Lenders may also want to know your broad plans for how the property will be used.
But should you satisfy these initial criteria, the lender will allow you to proceed to the application stage.
3. Applying - Banks will usually be more stringent on this requirement than, say, online mortgage lenders. But in most instances, lenders will want to see some or all the following documentation before they can proceed with your application:
- business financial statements, including balance sheets and income statements
- Proof of identity and contact information, and proof of any existing lease or tenancy agreements you currently have
- tax returns for both you and your business
- at least 2 years’ worth of bank statements for you and your business
- profiles of all business partners and directors
- a business plan with projected earnings
- your credit history and current FICO credit score
The application process normally requires that you detail the exact commercial mortgage product you are seeking, including the type of mortgage, the loan amount, a fixed rate or variable rate facility, and the term of the loan.
Commercial mortgages are typically issued at LTV ratios of up to 85% of the property’s value, with the agreed rate dependent on the value of the property, as well as possibly your creditworthiness. The lower the LTV ratio – and therefore the more of your own money that you are willing to invest up-front – the higher the chance your application has of gaining approval, and receiving favorable loan terms.
Hard money lenders – those that determine your loan approval based on the value of the property being purchased - will typically charge a higher rate and stipulate a shorter term for the loan to reflect the higher risk than a traditional lender.
It is also worth being aware of the additional fees for which you are liable, including appraisal fees, legal fees and valuation fees.
4. Approval – the approval process can take months to complete. During this time, representatives from the lender are also likely to visit the premises to conduct an appraisal, for which you must pay a fee. A legal process is also undertaken to ensure there are no existing liens on the property
Once your mortgage application is approved, you then attend the closing to sign the final contract. The lender then issues you the funds, as agreed.
Pros of Commercial Mortgages
Benefits of Ownership – a commercial mortgage can prove vital in providing the necessary funds for you to own the business property of your dreams. Once the repayment term is complete, you retain full ownership of the premises without having to make additional monthly payments, whereas renting or leasing a property requires you to continue paying indefinitely without gaining ownership at the end.
Compared with renting or leasing, moreover, ownership gives you more freedom in the end to do/change/refurbish your property as you wish, and even more so after you finish repaying the loan in full and collateral is returned to you.
Equity Growth - With real estate typically enjoying long periods of price appreciation, there is a good chance that you will enjoy strong equity growth if you remain at this premises for the long-term.
You can then realize substantial gains when you sell the property and relocate to enable further expansion. Or staying at the same property which has appreciated in value will enable you to leverage it for acquire finance at more favorable terms.
Lower Rates – compared to other forms of debt financing such as business lines of credit, commercial mortgages typically offer lower interest rates. As such, this funding option is more affordable in terms of monthly repayment obligations, which can be crucial for smaller businesses needing to free up as much cash flow as possible.
Choice of Rate Structure – with both fixed rate and variable rate repayment options available, you can protect yourself against the impact of adverse changes in market borrowing rates.
For example, if you believe that interest rates will mainly continue to rise over the next few years, securing a fixed rate commercial mortgage at currently lower rates will shield you from those rate hikes. And if you anticipate rates will largely fall going forward, a variable rate commercial mortgage will make more sense as your mortgage rate will follow the broader market down, resulting in lower monthly repayments.
Property Flexibility – does the property you acquire have extra unused space that can be leased to a third-party? If so, the monthly rental income that you earn from hosting, say, another business, can be used to offset your own monthly commercial mortgage repayment obligations and thus prove essential in freeing up cash that can be allocated towards business expansion.
And if you have completely paid off your mortgage, this source of rental income can become a wholly additional, standalone source of revenue for as long as you remain on the premises.
Cons of Commercial Mortgages
Sizeable Deposit Required – the deposit required for you to secure a commercial mortgage is often substantial, and could severely limit the cash you have available that could instead be used to service other crucial business requirements.
Interest Rates – as stated above, the option to choose between a fixed rate and a variable rate commercial mortgage can be fruitful if you correctly anticipate the future path of market interest rates.
If your predictions are incorrect such that interest rates remain largely lower than your agreed fixed rate, or they remain largely above your agreed variable rate, then you could end up paying substantially more in loan repayments over the entire term of the mortgage.
Ownership Costs – the shift from being a tenant to an owner can be accompanied by a potentially dramatic escalation in costs for which you are now responsible, rather than your landlord. Costs include maintenance of your property, security, furnishing costs, utility costs and insurance.
Should you own the property but want to move to a bigger premises, perhaps to accommodate an expansion of your business – the move can be complicated and costly, certainly more so than had you simply rented the place.
Fees – there are also a slew of additional hidden fees that accompany property ownership for which you are liable, including arrangement fees, valuation fees, legal fees and appraisal fees. None of these charges are required if you rent/lease your property, and they typically amount to several thousands of dollars.
To compound matters, some of these charges are mandatory irrespective of whether your mortgage application is approved or rejected. So, it is worth being as sure as possible that your application will ultimately be approved.
Collateral – with the property serving as collateral against the mortgage facility, it is incumbent on you to keep up with your monthly loan repayments. If you default, you could well lose the property.
