Making the Right Choice with Commercial Property Mortgages

Rental prices for commercial premises are currently staggeringly high across the country. First-time businesses often struggle to make profits once the rent has been paid on second-rate premises, while enthusiastic entrepreneurs once looking to expand may decide to abandon developments.

Investors who might have once opted for rental properties as a default are now deciding on commercial mortgages as the right move forward. Buying your own premises for commercial activity is an enticing prospect but there’s a minefield of mortgage implications to consider.

Choosing The Right Commercial Property Mortgage

Rental prices for commercial premises are currently staggeringly high across the country. First-time businesses often struggle to make profits once the rent has been paid on second-rate premises, while enthusiastic entrepreneurs once looking to expand may decide to abandon developments.

Investors who might have once opted for rental properties as a default are now deciding on commercial mortgages as the right move forward. Buying your own premises for commercial activity is an enticing prospect but there’s a minefield of mortgage implications to consider.

What should you expect with a commercial mortgage?

Although there’s plenty to be wary of with commercial property mortgages, there are several reassuring factors. Unlike businesses who rent their premises out, there’s no ongoing worry of a landlord suddenly upping monthly rents and other charges. Generally speaking, monthly mortgage repayments will remain stable, although there’s always the chance of gradual increases should you opt for a variable rate mortgage deal.

There are lucrative benefits of a commercial mortgage besides stability. If the value of the property your business calls home increases, so does your business capital. Tax-deductible interest repayments further strengthen the case for a commercial mortgage. Depending on the flexibility of your rental agreement, you could also consider sharing your premises with another small business. If your property landlord agrees to such an arrangement, the extra income provides welcome financial relief, month to month.

Commercial mortgage repayments

When it comes to understanding repayments, things are reassuringly simple and somewhat similar to residential mortgage repayments. One of the chief differences is that commercial mortgages have a generally higher interest rate applied to them, due to the fact they are deemed a high-risk venture on the part of the lender. As with mortgages for other types of property, commercial deals that carry a higher perceived risk can command a larger deposit. Deposits that amount to at least one-fifth of the overall value of a commercial property are often advised.

Types Of Mortgages For The Commercial Property Market

Although the commercial property market is relatively complex due to the variety of the premises across it, commercial mortgages can be boiled down to a few major types.

Owner occupier mortgages

First, let’s consider the most obvious type of commercial mortgage scenario: mortgages for owner-occupiers. In this instance, a business may wish to purchase the premises that currently serves as its base of operations. This is often the next step for businesses looking to expand. Additionally, a company may seek an owner-occupied mortgage to purchase new premises where the business activity will be relocated to.

Residential buy to let

Also commonly encountered in the commercial mortgage market is the residential buy-to-let mortgage. This arrangement sees residential properties purchased with the intention to be let out to tenants. Those seeking a residential buy-to-let mortgage are most likely to be full-time landlords looking to expand a portfolio of rental properties. More recently, a rising number of buy-to-let companies have sought similar mortgage deals with the same goal as private landlords.

Commercial buy to let

More specific to the world of business is the commercial buy-to-let mortgage type. In this instance, a company may wish to buy new premises for the purpose of letting it to another company. It’s a similar setup to residential buy-to-let mortgages, although lenders are generally more discerning in who they lend to. Would-be borrowers can expect lenders tend to focus on several risk factors unique to commercial properties as part of their application approval, such as that commercial properties often have a harder time finding rental tenants than residential ones.

Where Should You Look For A Lender?

If you’re keen to progress with procuring a commercial mortgage, the good news is that there’s a healthy variety of options available to you. Those new to the world of commercial property mortgages need to seriously consider the range of lenders on offer, with each provider offering distinct perks and drawbacks.

High street banks

An easy option for first-time commercial property buyers are high street banks. Those eligible for a mortgage deal for commercial property will find their attractive rates hard to refuse. These lenders will tend to lend loan amounts against the open market value of the property in question, with the lend-to-value ratio is considerably higher than what you might find elsewhere. The result is you can enjoy a larger overall mortgage, giving you much more freedom and spending power for when it comes to setting up a new property.

However, it’s not all smooth sailing when it comes to high street bank lenders. In particular, the criteria set out by these lending institutions are often quite strict, making it difficult for first-time applications to satisfy lenders that they are ideal candidates for an investment.

Challenger banks

Beyond the high street, other lenders that deliver in the areas where mainstream banks don’t can be found. These so-called challenger banks have the immediate appeal of more lenient criteria, with lower DSCR requirements better suited toward businesses that have a relatively low monthly income.

Worried about credit issues tarnishing your chances of getting an agreement on a commercial property mortgage? Major banks will most likely refuse to any would-be buyer with poor credit history, but this isn’t a foregone conclusion with a challenger bank.

Those seeking more affordable repayment options can also look toward challenger banks for interest-only packages. This can total loan-to-value amounts. For example, a business with more modest expectations might be searching to buy due to cashflow issues. This is particularly true in instances where an interest-only mortgage adds up to less than what current rental payments amount to.

The potential negatives associated with challenger banks include lower borrowing amounts, as they tend to take the 180-day marketing period approach to deciding on a mortgage amount, rather than the open market value. Alternatives to the high street are typically more expensive, with added premiums to be expected when it comes to things like exit fees. If you’re after the freedom of an exit clause, challenger banks might be best avoided, with sky-high exit fees a real financial hindrance and hurdle to what you do next.

Specialist lenders

If flexibility is a first-rate concern, we advise approaching specialist lenders. These lenders are often smaller in size and can provide younger companies who are looking to borrow with a real shot at succeeding at an application.

Specialist lenders are more open to briefer trading histories and have a lower affordability criteria. If you’re really struggling to make a case for a loan elsewhere on the market, specialist lenders may also consider detailed projections and proposal documents as part of your application. You’ll need to ensure your application is as detailed and accurate as possible, with full support and input by your accountant.

One of the biggest drawbacks of specialist lenders is that they are almost always more expensive for borrowers who’ve had no luck with banks. Instead of lending against the open market value, these lenders can often go against the forced sale value instead. This means you’re almost certainly going to be more limited with the amount you can borrow to pursue property purchases.

Longer terms come as a standard here. Like challenger banks, significant exit fees are also likely to sting. What’s more, if you have seriously exhausted all other lending avenues, it’s a reasonable shortcoming to have to live with.

Are you eligible?

Like most other financial products, your credit history is important when applying for a commercial mortgage. When you’re looking for a business mortgage, trading history is taken into account too. In short, nobody is going to lend to a business that can’t afford the mortgage payments laid out in an agreement in accordance with the repayment schedule.

If you’re a limited company, you must ensure you have a minimum of three years of filed accounts at your disposal to provide bank lenders with. If you’re applying with a challenger bank, you can expect less intensive checks, although ensure you have a minimum of two years of accounts ready to go.

Things are a little different for those looking to launch a business with the purchase of a new property. For instance, lenders will expect you to have a sizeable financial sum at your disposal before they will even consider agreeing to a mortgage deal.

Let’s consider the example of a newly created business with zero trading history. The loan-to-value ratio will be set at 50% of the purchase price of a premises. Depending on the price of a property, that’s a huge sum of money for a new business with no cash flow, but it’s not without benefits.

How property use affects interest rates and lending limits

Commercial properties are incredibly diverse with an equally varied field of application. As such, it should come as no surprise that interest rates and borrowing amounts are heavily dictated by how you intend to use any given property.

If you’re looking at owner-occupied businesses to accommodate offices or retail endeavours, you can expect something in the region of an 80% loan-to-value at the upper limit. However, should you decide to segment the main property into smaller spaces with the option to lease to other companies, you can expect some serious adjustments in how your interest rates and borrowing amounts are worked out.

This type of property usage would be classed as a commercial buy-to-let business. With these types of properties, loan-to-value is brought down to no more than 75% at the upper limit.

You can also expect an increase in interest rates. With commercial buy-to-let, there’s already a starting minimum of 3% over the base rate of the Bank of England. Unless you’re fully committed to a commercial buy-to-let business, you may be better off using your new commercial premises for something more conventional to avoid these imposing interest rates.

Location limitations

If you’re already an established business with multiple properties within the same regional area, there are additional considerations when it comes to pursuing further commercial mortgages with lenders.

When it comes to commercial properties and lending limits, something called the concentration limit comes into play. It’s a reasonable risk factor for lenders to be concerned about, with the argument that when the market in a given area suffers, customers with multiple properties can be hit hard. Those who have a property portfolio that’s more geographically scattered are less likely to be hit by downturns in the market, posing less risk for lenders.

Planning permission

Businesses with expansion plans in mind will also need to prioritise planning permission when pursuing mortgage funding. Understanding the possibilities for planning permission gives a good idea of how profitable a given property might become, or alternatively where it might suffer. Conventional banks will almost always bring planning permission into consideration when calculating an offer.

Unlike high street banks and established lending authorities, challenger banks and specialist lenders give more leeway to applicants when it comes to planning permission. It’s not a universal truth, but these banks and lenders will often consider mortgage applications from borrowers without probing into planning permission.

Size up securities

It’s reasonable for lenders to insist upon security when it comes to commercial mortgages. It offsets possible risks to the lender when they provide significant mortgage amounts for large commercial premises. Some buyers, however, may find the security requirements of a deal too high. However, those knee-jerk reactions might not always be the best response.

An understanding of equity is essential here. Asset values cannot be used to determine what level of mortgage you’re entitled to. To get a better idea of how much can be realistically borrowed, lenders look to ascertain how much equity a property might still offer, with multiple valuations used to calculate this. In most instances, the forced sale value is used. Lenders will also consider whether the security in question has any outstanding debt against it. Typically, borrowers will need to have access to approximately 75% of the property value to be able to buy.

Should a buyer turn up short with cash deposits to handle the completion of purchase, lenders will likely request further security if they are to help you with the final purchase of the property. Such a situation often arises with businesses that have considerable cashflow still tied up in active business operations or assets. This type of arrangement is an ideal option for those who boast healthy assets but suffer from a shortage of readily available funds.

The wide field of lenders on the market today means that borrowers may be surprised at the range of securities required. Different lenders look for different assets when agreeing upon applications, which is something that new borrowers and those who’ve had hassle-free deals before can have trouble accepting. It’s certainly more of an issue when dealing with larger mortgage amounts.

Some lenders have a preference for particular property types when singling out security, whilst others might prefer other assets as primary security assets. Unsurprisingly, size and location are further deciders for lenders when it comes to outlining a securities agreement on a commercial mortgage application.

Prepare for fees

Multiple fees need to be considered when applying for a commercial mortgage. Some of these are relatively minor, while others are more significant and represent a huge financial investment. If you’re feeling uncertain about anything during the process or are in a situation where outgoings need to be monitored down to the smallest sum, keeping track of fees and charges is an absolute must. Below you’ll find a breakdown of the most commonly encountered fees you can expect.

Arrangement fees:
When a mortgage agreement is completed, some arrangement fees are added to the loan capital. Many lenders may want to protect themselves against loss on initial stage work carried out by their teams, which is why so-called ‘commitment fees’ are often included in the arrangement fee. This fee is often part of the application stage and tends to be non-refundable. In general, expect arrangement fees to total no more than 2% of total loan amounts, with smaller loan amounts resulting in higher rates.

Valuation fees:
Commercial properties are more variable than other types of property, especially residential ones. When it comes to residential properties, lenders often don’t need to send a valuer to the property to make a valuation. However, lenders will send a valuer to a commercial property gather information for a detailed report. This will form the basis of their mortgage offer to buyers. Starting fees of £500 aren’t uncommon for commercial valuations, although a more expansive property might involve a valuation at a much higher price. Valuation fees can usually be paid to lenders once a formal offer for a mortgage deal has been accepted.

Broker fees:
If you’ve called in the service of a commercial broker specialist, you should expect to pay a premium for their market insights and access to their extensive network. A broker will provide a case for an application to your would-be lender, making sure you’ve picked one you can work well with and trust.
If you don’t feel like your broker is giving you the right information or clouding over shortfalls in your application, lenders will notice this too. Don’t be tempted to use multiple brokers concurrently to ensure you land the best deal possible; you don’t want to fall foul of the lenders themselves and end up being turned away on all fronts.
Make sure a broker is a NACFB member. Professional Indemnity insurance and adherence to the codes of practice are also standards to stand by. Brokers can charge fees equalling around 1% of the overall loan value. Don’t agree to pay anything to a broker until they have provided you with a copy of the loan offer, laying out all the terms and conditions of the agreement.

Legal fees:
You’ll be accountable for legal fees for both your side and that of the lender. Depending on the property you’re pursuing, fees can vary wildly when it comes to legal activity. As a minimum benchmark, you can expect starting figures of about £500 for yourself, and a further £500 for fees to cover the lender.
You can make efforts to ensure savings are made throughout the process. A common way to bring legal fees down across the board is to ensure you and your lender are using the same legal representation. Should you and your lender be handled by the same firm, there’s a more clear price policy in place.

Choosing the right commercial mortgage product

There’s a wealth of options to consider in the commercial mortgage sector, which is refreshing but also confusing for those new to the sector who require a highly tailored product.

Fixed, variable and mixed rate

It’s possible to find fixed rate mortgages on commercial properties. With assurances of no price rises from month to month, you can keep a good overview of financial outgoings for a set period of time.

You also have the option of variable rates, or you have a mortgage that blends elements of fixed and variable rate mortgages. Think long and hard about what works for you here. Monthly repayments will become a major part of your life, while the climb for mortgage equity gain is determined by the rate you choose.

Stamp duty and interest rates

Stamp duty is payable on all properties costing in excess of £150,000. The cost is calculated as a percentage of the overall price of your property. Accountants can more accurately advise you about your obligations here and any changes to policy. Interest rates are also essential considerations for commercial mortgage hunters. They can be fixed against the base rate or LIBOR in some cases. Elsewhere, lenders will require borrowers to provide a cash deposit or extra securities in order to minimise risk to them.

Extra fees

We’ve outlined the fees you can expect when applying for a commercial mortgage already, but it’s worth reiterating that they can amount to a considerable sum. If you’re someone who is keen to keep as much capital as they can reserved for business benefit, we advise you investigate what fees may come your way and what negotiation is possible when it comes to paying them. Additionally, make sure you’re getting your worth from vendors and service providers when paying these fees.

Additional costs

You’ll want to save as much money as possible if you’re moving your premises into a new building. If you’re using a mortgage to buy a premise for a new company, there are many more starting costs to consider. You may decide you need some extra funding options to cover the incidentals of a new business venture. Make a thorough note of all refurbishment costs and other amounts that might accrue as you get your building up for task.

Future prospects for profitability

Your circumstances may change in the future. Even if a company is doing well, it might not be thriving enough in a competitive market. You may decide to expand into other areas, but divert finances from your main premises. Offsetting future shortfalls by reconfiguring your property is an ideal way of providing yourself with a future income stream. Whether it’s refitting a premise for future business owners to ensure a sizeable profit on investment or developing a space to share with other business tenants, ensure planning permission is primed ahead of time.

Get in touch for further guidance

We hope you now have plenty of useful insights in our guide to commercial property mortgages. Whether you’re looking for more information about whether or not a commercial property mortgage is right for you or you’re planning to expand your business empire with new premises, get in touch with at Prideview Group to see how we can help you achieve your dreams.

Get in touch with us today to kick off the conversation.

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