Business owners considering purchasing an office or warehouse site to house their business are warned to conduct thorough research and seek professional advice. According to Smartline Personal Mortgage Advisors, while purchasing a commercial property can be very advantageous, the differences between residential and commercial lending warrant close attention.
Smartline Managing Director, Chris Acret, said market competition had a significant impact on the costs associated with a commercial loan.
“There is a lot of competition in the residential lending marketplace and so lenders have taken steps to make their loan products more attractive than other lenders’ products,” says Acret.
“Compared to a commercial loan, the interest rates are lower, there are cheaper upfront fees, and there are more options, like redraw and repayment holidays.
“With commercial loans, however, the interest rates are higher – sometimes significantly – there are much higher upfront fees and ongoing fees related to loan reviews, which are required by lenders as part of their risk management and mitigation, and the loan to value ratios are much lower, which means borrowers have to come up with significant deposits.
“From the lenders’ perspective, commercial lending exposes them to a far greater level of risk, which involves a variety of additional costs to be funded and obligations that must be met.”
Acret says the type and value of the property influenced how much a lender was willing to fund. Generally, commercial property borrowers could expect lenders to fund up to around 75% of the value of the property – but as little as around 65%, or less.
He adds there were a number of differences between commercial and residential lending.
“Some major lenders will only approve commercial loans over a maximum 15 years, based on the ‘usable life’ of a commercial property – this compares to 30 years for residential loans,” Mr Acret said.
“To illustrate the difference, let’s look at a commercial property valued at $800,000. You would require about 25% deposit – that’s $200,000 – as well as fees and charges of approximately 5% – about $40,000 – and other charges, such as the cost of a valuation and the application fee – that’s about another $2000. All up, you could be looking at around $250,000 to fund the purchase.
“The $600,000 that you borrow from your lender then needs to be repaid over 15 years, requiring payments of about $5,770.00 per month.
“Commercial properties vary in price across the spectrum compared to residential property prices”.
Acret says there were risks unique to commercial areas, such as the impact of changes to infrastructure that can severely impact property values.
“This was the case in eastern Melbourne some years ago where a new ring road was built in the western suburbs that virtually linked the ports, airports and Hume Highway,” he said. “As a result, a number of factory owners in the east decided to relocate to the west to leverage the development’s benefits – making commercial property in the east less desirable and, therefore, values fell.
“Unlike residential property, commercial property is vulnerable to changing economics, infrastructure and even consumer behaviour, and this must be factored into your investment plan.
“Lenders also look closely at the level of risk associated with niche sites, as opposed to retail shop fronts for example.
“Add to that a higher interest rate of around 1.5%, depending on the lender, and a loan term of around 15 years – or whatever you have negotiated with the lender – as well as the requirement by some lenders for regular reviews of the borrower’s financials, and you can see the risk factors, costs and commitment required to fund a commercial property investment are very different compared to residential.”
He adds that commercial property lenders would consider five years interest-only, but the maximum term was 15 years with the major lenders.
“There are some niche players that will consider loan terms of 25 years whereby the loan is very much ‘set and forget’, meaning there is no need to conduct regular reviews and there are no ongoing fees,” he said.
“However, the major lenders conduct annual reviews, which include a review of borrowers’ business financials.”
There are a number of ways to structure lending to purchase commercial property, says Acret, but he advises borrowers to seek advice.
“If you’re considering investing in commercial property, it is critical to work with a mortgage adviser with experience in commercial lending to tailor lending to suit your unique situation,” he said.
“Investing in commercial property is not fraught with danger, but there are certainly a number of considerations to be made. Done well, there are many benefits for small business owners.
“As with any investment decision, if you’ve done your research and you have worked with a professional, then you can reap the rewards.”
For an indepth examination of the current state of the commercial property market, pick up a copy of the October issue of Your Investment Property, on sale now!
