How to Finance Commercial Property
Are you a property investor looking for your next acquisition? The initial stage of this journey is uniquely exciting, but navigating commercial property finance can often seem daunting.
In this guide, Fortis Capital makes things simple. Expect to learn how to finance commercial property, the benefits this can bring, and a streamlined 4-step application process that you can use to your advantage.
Read on to begin your next project with confidence, and don’t hesitate to contact the Fortis Capital team with questions and to schedule a personal consultation.
What is Commercial Property Finance?
Commercial property finance refers to specialised loans and funding options designed to support commercial real estate. It empowers investors to purchase existing properties such as offices, retail spaces, warehouses, or industrial properties and refinance current commercial property loans.
Commercial property is generally a longer term investment strategy and because of this main bank options are usually always favoured. There are both bank and non bank funding options for commercial property transactions, however its critical investors only use non bank options for the short term and have a plan to position the asset to eventually meet bank criteria.
How Does Commercial Property Finance Work?
Commercial property finance provides the leverage you need to complete a transaction. But how exactly does it work? Here's a breakdown of the key elements:
Loan Features
Loans typically range from $500,000 to several hundreds of millions of dollars catering to anything from a strip retail unit to a multi asset property fund.
Although we do see loan terms up to 15 years, generally commercial property finance is provided for a maximum loan term of 5 years, however this will be conditional on an acceptable Weighted Average Lease Term “WALT”. Specifically, the WALT measures the weighted average remaining contract lease term for all tenants at a property. A lender will structure their loan term to expire within the WALT to provide a healthy buffer upon expiry. This manages the risk of tenants not renewing, putting pressure on cash flow.
A lender will assess the Interest Cover Ratio “ICR” of the transaction which is calculated as the net income derived from the property / the forward looking interest expense. A bank may require an ICR in excess of 1.40x whereas a non bank may be comfortable with 1.00x.
A lender will assess the Loan to Value “LVR” which is calculated as the total facilities / either the purchase price or valuation prepared by a Registered Valuer. Main bank’s generally tap out at 65% LVR and some non-bank options will accept up to 70%. This is on the basis that the WALT and ICR threshold are also met. In the current high interest rate environment usually the maximum funding is dictated by the ICR.
Repayment options can be tailored to your cash flow, with choices like principal and interest, interest-only and prepaid interest (non bank only).
Interest Rates
Interest rates for commercial property finance vary depending on several factors. Banks set their interest rates using a risk-based pricing model. In this model, the bank evaluates various factors related to the loan—such as the WALT, ICR, loan term, and tenant profile to ultimately assess the risk of default. The bank then applies a credit margin and fee structure necessary to meet its internal return targets, which is added to the base rate of the loan. We are currently seeing main bank interest rates between 6.50-7.50% for commercial property transactions.
Non-bank lenders charge more for the benefit of the added flexibility and funding. Interest rates can range from 9-11% with an added fee structure between 1-2% depending on the lender.
How Does Commercial Property Financing Differ from a Residential Home Loan?
While both residential and commercial loans help you acquire property, they generally cater to different needs. Here's a breakdown of the key differences:
Purpose: Residential home loans are designed for purchasing a home for personal use. Commercial property finance, on the other hand, fuels the acquisition of properties for investment purposes, such as offices, retail spaces, or industrial assets.
Loan-to-Value Ratio (LVR): LVR refers to the amount you can borrow compared to the property's value. Residential mortgages typically allow for higher LVRs (up to 90% in some cases), whereas commercial property financing often has stricter requirements with a lower LVR (around 65-70%). This reflects the higher risk of default associated with commercial property.
Interest Rates: Commercial property loans carry higher interest rates compared to residential mortgages. This is due to the factors mentioned above, with lenders generally viewing commercial as riskier, requiring the allocation of more capital.
Loan Terms: Commercial property loans typically have shorter repayment terms than residential mortgages. This may range from up to 5 years, compared to the 25-30 year terms common with residential loans.
How to Finance Commercial Property: A 5-Step Guide
Financing commercial property can be simple with the right approach. While borrowers can approach lenders directly, we recommend all borrowers engage the assistance of a reputable advisor such as Fortis Capital. This will ensure the transaction is presented correctly and the right lenders are engaged that align with your purpose.
Here’s the process we recommend following:
Define Your Purpose
When approaching a lender you will want to clearly outline your goals for completing the transaction. Are you seeking acquisition funding for a new purchase, funding to assist with a refinance of existing commercial property funding or short term non bank funding while you reposition and release the asset before refinancing back to a main bank.
Prepare an Information Memorandum
A detailed Information Memorandum will be prepared detailing all the key details of the transaction to support your application. This will include the legal ownership structure of the asset, professional background of the individuals, a tenancy schedule summarising lease details, financial accounts, valuations (if available), IEP report and the requested debt position.
Engage with Lenders and Compare Options
Once the Information Memorandum is prepared we then will engage with a panel of preferred lenders that align with your purpose. We seek and then analyse multiple indicative offers and ultimately recommend the best course of action for your transaction.
Loan Approval and Closing
The elected lender will then approve your application. Once approved, we work with the lender to finalise the loan documentation, satisfy conditions precedent and complete the settlement.
The Takeaway: Choosing the Right Lender Can Streamline Your Commercial Property Financing
To discuss your upcoming commercial property purchase, contact the team at Fortis Capital today. Our commercial property finance in Auckland is built around flexible lending options and a deep understanding of the needs of property investors in NZ. Contact us today and let’s discuss the future success of your commercial property venture.