Commercial Property Mortgage Tricks & Tips

When it comes to commercial property lending, lenders assess a variety of factors to determine the risk and viability of the loan. Unlike residential property loans, commercial loans are often considered riskier due to market fluctuations, tenant reliance, and the potential variability in property values. Lenders evaluate both the borrower’s financial position and the property’s characteristics to ensure the investment is sound.

Here are the key things lenders typically look for in commercial property lending:

1. Type of Property

• Property Classification: Commercial properties can vary significantly, including office buildings, retail spaces, industrial facilities, and mixed-use properties. Some property types (e.g., offices or warehouses) may be considered lower risk than others (e.g., hotels or specialized-use buildings) due to differences in market demand and tenant stability.
• Tenant Quality: Lenders will evaluate the quality of the tenants occupying the commercial property. Long-term, stable tenants with strong credit ratings, especially national or international businesses, increase the lender’s confidence in the investment.
• Location: As with residential properties, location plays a major role in commercial lending. Properties in prime, high-demand locations (e.g., central business districts or industrial hubs) are seen as less risky than those in less desirable areas. The lender will assess the local economy, business activity, and future growth prospects of the area.

2. Loan-to-Value Ratio (LVR)

• LVR Thresholds:Lenders typically offer lower LVRs for commercial loans compared to residential loans. For commercial property, the LVR might range from 60% to 70%, meaning the borrower needs to contribute 30-40% of the property’s value as a deposit.
• Lender Risk Appetite: The lower the LVR, the less risky the loan is for the lender. If the property’s value decreases, a lower LVR provides a buffer. Borrowers with a higher deposit or significant equity in other properties are seen as less risky.

3. Borrower’s Financial Strength

• Financial Statements: Lenders will look at the borrower’s financial health, including income, assets, liabilities, and cash flow. They will often request financial statements for the past 2-3 years, such as balance sheets, profit and loss statements, and tax returns. This is particularly important for businesses applying for the loan.
• Serviceability: The lender will assess whether the borrower can service the loan (i.e., make repayments). This involves looking at the rental income from the property, the borrower’s other sources of income, and whether they have the capacity to cover the loan even during periods of vacancy.
• Creditworthiness: The borrower’s credit history is a key factor. A good credit score and a history of repaying debts on time show the lender that the borrower is reliable and can handle loan repayments.

4. Rental Income and Lease Terms

• Rental Income Stability: Lenders want to ensure that the property generates sufficient rental income to cover loan repayments. Properties with established, long-term leases provide more certainty for the lender.
• Lease Terms: The length of the lease and the conditions attached to it are critical. Long leases (e.g., 5-10 years) with stable tenants reduce risk, as they ensure the property will have a consistent cash flow. Lenders also look at who is responsible for expenses such as repairs, maintenance, and rates (known as net leases or gross leases).
• Vacancy Rates: High vacancy rates reduce the property’s ability to generate stable income and increase the risk for lenders. Properties with full occupancy or low vacancy rates are preferred.
• Tenant Turnover: A high turnover of tenants could be seen as a risk, particularly if it’s in a niche market where finding tenants is challenging.

5. Property Condition and Market Value

• Property Condition: Lenders will assess the current state of the property. Properties in good condition are easier to maintain and less likely to require major renovations or repairs, reducing risk. They may also conduct an independent valuation to assess its current market value.
• Potential for Capital Growth: Lenders will also evaluate the potential for the property’s value to appreciate over time. This includes considering trends in the commercial property market, local infrastructure developments, and future economic conditions.

6. Debt Coverage Ratio (DCR)

• DCR Calculation: The Debt Coverage Ratio (DCR), also known as the Interest Coverage Ratio (ICR), is a measure of the property’s ability to generate income relative to the loan repayments. Lenders typically look for a DCR of at least 1.25 to 1.5, meaning the property generates 25-50% more income than the required loan repayments.
• Positive Cash Flow: A higher DCR means that the property generates more cash flow than is required to service the debt, reducing the lender’s risk.

7. Loan Term and Interest Rate Type

• Loan Term Length: Commercial property loans often have shorter loan terms than residential loans, typically ranging from 3 to 15 years. Lenders prefer shorter terms as they reduce risk, but this means the borrower may face higher repayments or the need to refinance sooner.
• Fixed vs Variable Rates: Lenders will offer either fixed or variable interest rates. Borrowers seeking stability may opt for a fixed rate, while those wanting flexibility might choose a variable rate. The lender will assess the borrower’s ability to manage potential rate changes, especially for variable-rate loans.

8. Borrower’s Experience

• Experience in Commercial Property: If the borrower has prior experience in managing or investing in commercial property, they are often seen as less risky. Lenders prefer borrowers who are familiar with the challenges and complexities of commercial property ownership.
• Track Record: A strong track record of successfully managing or investing in properties can give lenders confidence in the borrower’s ability to manage the new asset effectively.

9. Market Conditions

• Current Economic Climate: Lenders will evaluate broader market conditions, such as the strength of the local economy, business confidence, and demand for commercial property. In uncertain economic times, lenders may be more cautious and impose stricter lending criteria.
• Commercial Property Trends: Lenders may also consider trends in the specific commercial property sector (e.g., retail, industrial, office) to assess the future prospects of the investment.

10. Loan Structure and Guarantees

• Personal or Corporate Guarantees: In many cases, lenders require personal or director guarantees, especially if the borrowing entity is a company or trust. This gives the lender additional security if the borrower defaults on the loan.
• Additional Collateral: Lenders may also seek additional collateral, such as other property assets, to secure the loan. This lowers the risk for the lender but increases the stakes for the borrower.

Summary of What Lenders Look for: