With so many commercial property finance options available, it can be difficult to determine the best way to finance commercial property for your business. Purchasing commercial property is a complicated process. While there are finance options for those who need funding quickly or are trying to purchase commercial property without all the money you would ordinarily need, these methods can pose significant risks to your business should you be unable to make repayments.
Fortunately, our team of knowledgeable commercial property solicitors are here to help. In this post, we will talk you through the most common types of commercial property finance. We will highlight the pros and cons of each finance option, as well as alert you to any additional costs that might arise while you are purchasing your commercial property.
While this post provides a general overview, we recommend you direct any queries regarding financial and tax advice to your accountant.
When Is Commercial Property Finance Commonly Used?
There are many reasons why you might choose to finance your commercial property purchase. Most people obtain finance when they are buying commercial property but cannot afford to make the purchase outright, or (for cashflow, or similar reasons) would prefer not to.
The same can be said of purchasing commercial property that already has a business attached to it, such as a bar, restaurant, or hotel. In cases such as these, your commercial property finance would potentially cover the cost of the property as well as the business operating inside it.
In some cases, you may seek commercial property finance to fund the development of a property you already own. This can be achieved by remortgaging your commercial property to release some of the equity you have already accrued or by applying for a second mortgage on top of your first.
For the most part, business owners finance commercial property purchases for the same reason prospective homeowners apply for mortgages: to purchase commercial property without spending the full amount on the property.
What Types of Commercial Property Finance Are There?
There are several different types of commercial property finance available, each with its own advantages and disadvantages. These are all important to consider before entering into an agreement with your lender. We have included the most common ways to finance commercial property purchases below, along with all their pros and cons.
Commercial Mortgages
Much like residential mortgages, commercial mortgages are long-term loans offered by banks or building societies that allow you to purchase a commercial property by making a deposit followed by monthly repayments over the course of several years. The amount you deposit will vary depending on your lender, but for most commercial mortgages, you need to put down between 20% and 40% of the property’s value. The duration of commercial mortgages also varies greatly, with terms of up to 30 years.
Unlike residential mortgages, the interest rates on commercial mortgages tend to be much higher as commercial property purchases present a greater risk to the lender. As a result, your lender will ask you to provide multiple documents about you and your business, such as proof of identity, bank statements, tax returns, and business accounts, as well as to complete an assets and liabilities statement.
Using this information, your lender will calculate the interest rates for your commercial mortgage. The main factors your lender will consider are:
- The size of your mortgage
- The loan-to-value ratio
- How long your business has been trading
- The success of your business
- Your credit history
- If you have any debt
- If you are providing a personal guarantee
The nature of your commercial mortgage is similarly affected by who will be using the commercial property following its purchase. We have provided an overview of the three types of commercial mortgages below, as well as any additional information your lender will need in order to calculate your interest rate.
- Owner-occupied mortgages
This type of mortgage is to finance a business owner purchasing commercial property for their own use. This is the most straightforward type of commercial mortgage and provided you have the right documentation to hand, the application process could take a matter of weeks. However, it can take several additional months for funds to become available, so make sure your timeframe is properly communicated between your lender and your property agent.
- Commercial buy-to-let mortgages
This type of mortgage is for a landlord purchasing commercial property they intend to rent to another business. As your mortgage payments will be reliant on another business making their rental payments, your lender will scrutinise your business trading history before approving this type of commercial mortgage.
In most cases, your lender will request to see your accounts from at least the last three years as well as projected trading figures. However, you may also be asked to provide a tenancy schedule that outlines your tenant’s business as well as the full terms of your commercial lease.
- Residential buy-to-let mortgages
This type of mortgage is for a landlord who wishes to finance the purchase of one or numerous properties they intend to rent to residential tenants. This is ideal for professional landlords looking to expand their property portfolios, as it allows them to consolidate the mortgages of multiple properties into a single loan. As a result, your lender would expect you to provide evidence of your existing portfolio, as well as projected figures for future tenants.
What are the pros and cons of commercial mortgages?
There are plenty of advantages to using a commercial mortgage to finance commercial property purchases. We have listed the main benefits below.
- Accumulate equity: each monthly payment will increase your equity in the commercial property rather than be lost to a landlord.
- Lower interest rates: while higher than residential mortgages, the interest on commercial mortgages is lower than other unsecured business loans and tax deductible.
- Future investment: the property might appreciate in value over time.
- Profit potential: rental payments should cover the mortgage and provide some profit if you rent the property to commercial or residential tenants.
For all their benefits, commercial mortgages also come with their own set of disadvantages.
- Large initial payments: commercial mortgages require larger deposits than residential mortgages, or if a smaller deposit is offered, your interest rates will be higher to compensate.
- Complicated process: you will have to provide your lender with a significant amount of documentation before they consider you for a commercial mortgage, which can result in a lengthy and complicated process.
- Loss of property: if your tenant is not paying their rent on time and you are unable to make your monthly payments, you could lose your property.
Bridging Loans
As the name implies, bridging loans are short-term loans that can be used to finance commercial property purchases until you have acquired some form of long-term finance, such as the proceeds of another sale or one of the mortgages discussed previously. In some cases, business owners take out bridging loans to cover the cost of urgent renovations or to pay the deposit for their commercial mortgages. If you choose bridging loans, remember that they are only one part of your commercial property finance journey.
Perhaps the most crucial difference between commercial mortgages and bridging loans is that there are no monthly repayments with bridging loans. This means your bank statements and business accounts will not influence your lender’s decision. Instead, you will need to offer one of your assets as collateral, such as the commercial property being purchased or property you already own, as well as a clear ‘exit strategy’ to pay the loan by the end of its duration. This could mean selling your commercial property, your own property or refinancing elsewhere.
What are the pros and cons of bridging loans?
For those needing quick funds for a commercial property purchase, bridging loans can be very appealing. Some of their main advantages include:
-
- Accessibility: your lender is unlikely to look at your income or credit score, making bridging loans much more accessible.
- Flexibility: lenders are open to offering bridging loans to finance various commercial property purchases.
- Speed: bridging loans can be arranged within 24 hours and the money can be made available within as little as two weeks.
- Single payment: without the burden of monthly payments, bridging loans could positively impact your cash flow.
As with any type of commercial property finance, bridging loans also have their shortcomings.
- Short-term solution: you will be expected to repay your bridging loan within a short timeframe, with most lenders allowing a maximum of 18 months, which can present issues if you are struggling to secure long-term finance.
- Higher interest rates: bridging loans are more expensive than most other forms of commercial property finance.
- Loss of property: if you cannot repay your lender, you might have to forfeit the property you were using as collateral.
Secured Loans
Sometimes referred to as ‘asset-based loans’, secured loans are long-term loans valued against one of your assets, which serve as collateral to guarantee the repayment of the loan. After conducting an independent evaluation of your asset, your lender will offer you a loan equivalent to a percentage of its value. This means that you can be flexible with the amount you are borrowing, offering an asset equal to the loan amount you need to finance your commercial property purchase.
Lenders are willing to accept various assets as part of your loan agreement. From existing inventory or machinery to accounts receivable or other commercial property, most lenders are willing to accommodate to provide a loan that suits your situation. In some cases, your lender may allow you to serve dilapidated property as collateral and they would calculate its value based on its market potential after the completion of renovations, giving you the best possible deal.
Much like a commercial mortgage, secured loans are repaid monthly over a duration of three to 25 years, depending on the amount you are borrowing. Your lender will similarly ask you to provide documentation pertaining to your income, credit history and any other outstanding loans. However, the process is much less vigorous than for a commercial mortgage, as your eligibility is primarily tied to the value of the asset you can contribute.
What are the pros and cons of secured loans?
We have highlighted the main advantages below.
- Streamlined process: they require less documentation and are approved faster than commercial mortgages.
- Accessible: secured loans are ideal for those with inconsistent income or unfavourable credit history, as these criteria are less important to your lender.
Inevitably, secured loans have some drawbacks.
- Higher interest rates: they are more expensive than other long-term forms of commercial property finance, resulting in you eventually paying more than you would on a commercial mortgage with the same duration.
- Loss of asset: if you cannot keep to your monthly payments, your lender may seek to repossess one of your valuable business assets.
- Impact on future finance: due to their relaxed eligibility criteria, secured loans might offer a negative impression of your business to future lenders.
What Are the Costs of Commercial Property Finance?
Additional costs are involved in purchasing commercial property, which will vary depending on where you are in the UK.
Stamp Duty
Depending on the value of the commercial property you are purchasing, you may have to pay the Stamp Duty Land Tax in England and Northern Ireland. Similar taxes exist in Wales and Scotland, known as land transaction tax in the former and land and building transaction tax in the latter. We have outlined the details of each tax below.
- England and Northern Ireland
- You will pay 0% on property valued up to £150,000.
- You will pay 2% on the portion of the property valued between £150,001 and £250,000.
- You will pay 5% on the portion of the property valued over £250,000.
- Wales
- You will pay 0% on property valued up to £225,000.
- You will pay 1% on the portion of the property valued between £225,000 and £250,000.
- You will pay 5% on the portion of the property value between £250,000 and £1,000,000.
- You will pay 6% on the portion of the property valued over £1,000,000.
- Scotland
- You will pay 0% on property valued up to £150,000.
- You will pay 1% on the portion of the property valued between £150,001 and £250,000.
- You will pay 5% on the portion of the property valued over £250,000.
Business rates
As the name implies, business rates or ‘non-domestic rates’ are another variable tax that applies to property used for non-domestic purposes. In addition to where you are in the UK, your business rates are calculated based on the rateable value of your commercial property.
As these rates change year upon year, we would recommend that you visit the government website for more information on how to calculate business rates in England and Wales.
Do I Need a Guarantee to Finance Commercial Property?
If you own a small business or are starting a new business with a limited financial track record, your lender will likely ask you to provide a personal guarantee as part of your commercial property finance agreement. This guarantee offers additional security to the lender because, if you are unable to keep to your repayment schedule, you will be personally responsible for repaying whatever is left of the loan. In some cases, this can mean using your personal savings or even selling your home in order to make amends.
The thought of putting your personal assets at risk could be enough to dissuade some business owners from purchasing commercial property altogether. With help from one of our commercial property solicitors, you may be able to negotiate with your lender to decrease the amount you would be liable to pay or release you from liability once your business is more established to ensure your personal assets are protected.
If you need help deciding the best way to finance your commercial property purchase, or if you have purchased commercial property before and are exploring private equity or sale and leaseback as options to finance your next venture, reach out to a member of our team today. We can direct you to a trusted accountant contact.