Commercial Mortgages Explained

Posted by Alfred James Financial on 4th October 2021 -

A commercial mortgage starts where business loans finish. Unsecured business loans go up to about £25,000. Whereas with a commercial mortgage you can borrow up to millions.

A commercial loan is secured against commercial premises or against your residential property (as a secured business loan) when it is for business purposes and not for personal use.

Commercial mortgages typically require a higher deposit in comparison to residential mortgages and depending on the circumstances, a borrower can expect to pay between 25 – 50% of the market value of the property.

There are two different types of commercial mortgages: Investment and Owner Occupied. In this article we shall explore:

• The 2 types of commercial term mortgages
• The benefits of a commercial term loan
• How to apply for a commercial mortgage and what to expect
• Rates, and common questions answered.

Investment commercial mortgages

This type of commercial mortgage is used for when you want to let the property out.

Commercial mortgages can be used for a wide range of purposes including:

• Offices, including shared workspace
• Retail Units
• Garages
• Forecourts
• Warehouses
• Industrial units
• Purpose-built student accommodation
• Residential portfolios including HMO or multi-unit blocks.

Unlike an owner occupied commercial mortgage, an investment commercial mortgage is used to purchase any of the property types above and then letting them out to a long term tenant. This is a great way to diversify your residential portfolio, if you have one, or begin your property portfolio investment journey.

Top tip: not all lenders will accept first time buyers/ first time landlords. Most prefer that the borrower be a residential homeowner. Some lenders even require the borrower to have landlord experience. However, if you do not fit this criteria, we shall help you find a lender who will fit your criteria.

Owning commercial property could be a great way to get higher paying and long lasting tenants. This type of investment can be treated by many landlords as an investment vehicle or a short term cash flow provider.

However, there is a risk that is well worth considering which is that of relying on tenants, a thriving business, and fluctuating interest rates.

With any investment property, you’re relying on the longevity of the tenant to continue to provide an income that will cover the mortgage and other expenses.

Whilst it may serve as a great investment to buy an investment property, you’ll have to consider what a lender will call a “void period”. If you decide to let out the property, there is an assumption that there might be a void period at some point, where there is no tenant providing you with the cashflow necessary to pay for the mortgage.

Owner Occupied Commercial Mortgages

For many of our business clients at Alfred James Financial, having a commercial mortgage in order to invest in business premises can sometimes prove to be more profitable than renting a space to work in.

For example, this is a recent client we helped turn their liability into an asset:

Providing funding for owner occupier purchase of £1.1m gymnasium with development exit options at 70% LTV during the height of covid restrictions.

Our client, who is an experienced property developer, was looking to purchase a gymasium in London in need of strategic reinvestment with significant development exit options. Alfred James were able to support the client by helping with a focused business plan utilising a chartered accountant’s signed future cash flows of the business with covid contingencies.

Sourcing the funding proved especially challenging at the height of covid restrictions in a sector of the economy devasted by the pandemic closing the gymnasium and devastating the cash generation of the business at the time.

Utilising established relationships over many years Alfred James were able to present the deal to the chosen provider and source secured funding at 70% LTV with personal guarantees from client on a portfolio of assets.

What are the benefits of investing in commercial

Whether it’s for investment purposes or for your business, it’s still considered an asset with the potential of increasing in value.

We like to see our client’s portfolio grow which is why investing in commercial properties could benefit your cash flow and investment growth plans.

Here are a few reasons why you might want to think about taking out a commercial mortgage:

• The interest on your commercial mortgage is tax-deductible
• If your property increases in value, your capital could also see an increase
• You’ll be able to rent out the property to generate extra income

Whilst there are many benefits to being a commercial property owner, there are some risks worth mentioning. Above we discussed the risk of going through a “void period” in the leasing of a property. Planning a contingency plan for this potential risk could give you and the lender peace of mind.

Equally, as a business it might be great to own your own premises but the risk is that should the business forecast not look as profitable in comparison to prior years, then you’re still obligated to make the mortgage payments and therefore this monthly/annual liability could be uncomfortable.

Weighing up the pros and cons will help you plan for any contingencies should the unwanted happen.

Applying for a commercial term loan

A commercial mortgage application works similarly to taking out a regular mortgage for your home. Here are the steps to expect:

1. You complete and submit the Asset and Liability form

2. You’ll then be asked to complete the commercial mortgage application form: we can help you with this.

3. You’ll be required to provide information on your business (listed in the blue box below)

4. The property is valued

5. All legal due diligence will be carried out by the lender’s solicitors

6. If approved, you’ll receive a mortgage offer by the bank

It’s a good idea to collate the necessary documents ahead of time, so your application is processed more efficiently:

• Bank statements usually covering the last 3 months
• Trading figures usually covering the last 3 years
• Proof of identity and address
• Lease and/or tenancy agreements
• You may have to provide a business plan for financial projections – this could help the lender determine how likely you’re to be able to pay off the loan.

Commercial mortgage lenders will normally assess:

• The profitability of the business applying for the commercial mortgage. Lenders will use the profit generated by the business to assess the affordability of the commercial loan. With commercial mortgages normally spanning multiple years, a consistent track record of profit will be beneficial.
• Existing debt levels. Commercial mortgage lenders will take into consideration the existing level of debt in the business when assessing the affordability of the commercial mortgage.
• The property type and construction. Depending on the use, the construction of the property, the stability of the tenant and the alternate uses of the property.

The results of the three different requirements above, will determine which lender you will apply to because there are over 100 lenders each with their own criteria.

 

Rates, and common questions answered

Commercial mortgages can have interest rates that are fixed or variable, though the majority of commercial mortgages in the UK are more commonly offered with a variable rate.

A fixed commercial mortgage has terms that allow the borrower to repay a lower rate of interest for a set period of time (often between 2 – 5 years). You may find a specialist lender (with higher rates) offering interest only commercial mortgages for up to 10 years.

Once this interest only period is over, the borrower will begin to pay a higher rate of interest on the lender’s standard variable rate. If appropriate, the borrower can remortgage to another lender.

The average interest rate for a commercial mortgage in the UK varies heavily throughout the year and can increase or decrease based on a number of economical factors including:

• Brexit
• A recession
• A surge or fall in demand for property
• Even a pandemic as we experienced throughout 2020.

In 2020, rates have fluctuated between 2.75% and 7.5% with some lenders even coming out of the market all together.

An established, well connected mortgage adviser like us, can keep you up to date with all the changes in the market and find you the most appropriate lender every time.

Connect with us and let’s discuss the options available to you. Whether you’re looking to fund a ground up development or refinance your existing premises, we can help you.

Please visit our website and book a free consultation. No job is too big or small. We endeavour to help you achieve your goals.