The process for obtaining commercial finance, and preparing for a commercial purchase, is a lot different to what many investors would be familiar with in the residential setting.
So let’s look at some of the key differences between commercial and residential lending to help you understand the difference.
Commercial finance examples – for commercial property investors
This could be for a property investor who has a large equity position and is now looking at commercial real estate either to diversify their portfolio, or to transition towards cash flow. This is the most common request we see and includes buying retail, office or industrial sites, which then are leased to commercial tenants.- Another common example is an investor buying a block of residential apartments, where the unit block has more than three dwellings, as this would most likely require what falls into the realms of commercial finance even though the security is residential real estate.
Commercial finance examples – for property developers
- Property developers seeking to develop a commercial site or pursue a residential development with more than three units require commercial finance.
- Property developers seeking ‘mezzanine finance’, to complete a project where the equity and original/ bank loan falls short of the total development cost.
Commercial finance examples – for businesses
- A Business that wants to buy the site where they operate their business (rather than pay rent).
- Business wants expansion capital to grow their current operation, or to acquire another company.
Examples of where individuals may require assistance from commercial lenders:
There are the times where we have obtained commercial finance for individuals who are not suited to the standard retail or residential finance channels
- An individual whose scenario or group structure is so large or complex, that they are effectively viewed by lenders as a commercial operation in their own right.
- We have also financed non standard loan requests, which need to be financed by commercial lenders, and written as non-regulated loans (e.g. not governed by the National Consumer Credit Protection act). The most common non standard loan request we see is from clients seeking a large equity release/ line of credit against existing property (residential or commercial), without documentation to support their intended use of the funds.
Everything is negotiable
One key point around business/ commercial finance is that ‘everything is negotiable’.
For this reason, specialist bankers or brokers can help save you a substantial amount of money, and secure more favourable terms for you.
That’s why it’s important you find someone with experience in commercial lending, who you can trust.
Another key point is that while most banks tend to be conservative with commercial finance, due to the inherent risk of commercial loans, the assessment process can actually be less rigorous in comparison to residential lending (because it is not as heavily regulated).
The commercial finance process
For commercial investors, here’s how to consider the basics of the commercial finance process… both in terms of structuring the loan, and to ensure you’re ‘finance ready’, for when the right asset becomes available.
#1 – basic loan terms
The term of the loan would likely be set at 5-15 years, or one year less than the lease expiry (or one year less than the ‘weighted average lease expiry’, if there are multiple tenancies)- Loan ratio – most banks will lend up to 60-70% for a strong/ non-specialised commercial property asset, however for riskier or more specialised commercial assets, the maximum loan ratio will be lower.
- Annual reviews are fairly standard, where the lender will want to sight financials, and possibly even conduct a new valuation on the security property.
- Security – often just first charge over the commercial property being purchased.
- Guarantees – director guarantees are common, less so are general security agreements (GSAs). Borrowers should always be careful providing more security than is absolutely necessary.
#2 – Indicative interest rates, fees & charges
- Rates – indicative interest rates tend to be higher than those for residential loans (commensurate with higher risk, and more work required to establish commercial facilities).
- Line fees – this is a fee payable on the loan limit to keep the full amount of credit available, it doesn’t apply to residential loans but it’s a common feature commercial lends.
- Repayments – Interest Only or Principal & Interest (often with no loading for Interest Only).
- Indicative establishment fees – often 0.5% of the loan amount (only payable at settlement).
- Indicative annual fee – varies, but typically higher than the fees charged via the residential lending channels.
- Valuations – the default position is that ‘borrower pays’.
- Bank legal fees – again the default position is that ‘borrower pays’.
#3 – assessment criteria
- Assessment tends to be based on a combination of interest cover ratio, tenant quality, remaining lease term, loan to value ratio, and rental yield.
These inputs typically go into the lenders’ risk model, and the deal can then be priced accordingly.- Interest cover is the key ‘serviceability assessment’ used in commercial lending, it is a measure of how many times the proposed income covers the likely interest cost.
- In this case it has more to do with the income profile of the asset being purchased (‘net passing rent’ is the common metric), and the prevailing interest cost (potentially with sensitivity margins applied by the lender).
- Commercial borrowers are still expected to have good credit, but unlike a residential loan, employment history and payslips do not play a major role.
#4 – process for securing approval
- Once an asset is identified, the closest equivalent to a pre-approval is what’s known as a ‘credit sanctioned term sheet’ – where high level support for the loan is provided by credit, and the key terms of the loan proposal are outlined as well.
- The lender will typically need additional information to formalise the loan approval, so before entering into an unconditional contract, it’s important to be clear on precisely what remains outstanding.
- To get prepared, we suggest progressing the below documents as early in the process as possible...
#5 – documents required
- Depending on the specific nature of the lend, the starting point is often a Statement of Position (e.g. list of assets & liabilities, income & expenses).
Then in terms of the financials/ tax returns required – this depends on what entity you buy the asset in: (confirm with your accountant upfront)
- If you’re buying in your business, then at least the last 2 years financials/ tax returns for the operating entities will be required.
- If you’re buying in personal names, then the last 2 years personal tax returns will likely be required.
- If you’re buying in a new company or trust established specifically for the purpose of buying this asset – then no financials or tax returns should be required (credit managers can always still request though).
- Lenders will also require confirmation of clear tax positions (your accountant can provide ATO portals).
- It is also helpful having a group structure including a summary of all properties and facilities held with other financial institutions.
#6 – Timing
- Once we have the Statement of Position, plus any financials/ tax returns from above, then a high level assessment can be completed, and a term sheet can be issued within approx. 5 days.
- If we have a credit sanctioned term sheet, and you then reach price agreement, or sign a purchase contract, we can typically secure Formal Approval c 2-3 weeks after that.
- Often a 60 or 90 day settlement is sufficient, but this is always best discussed with your broker/ banker on a case by case basis.
In summary:
Commercial real estate can be a strategic asset class for property investors who have built up a large equity position and are now looking to transition towards cash flow.
Before approaching a specific lender, it pays knowing where the broader market sits in terms of funding appetite, key loan terms, and of course pricing.
An experienced broker should have this information on hand, guide you through the process, and help you negotiate favourable terms.
