Financing a commercial property can be an exciting venture. But you must first check your credit before applying for a loan, as a poor credit score may stop you from being pre-approved for a loan. After reviewing your credit report, you should possibly consult with a finance expert.
When you invest in a piece of commercial property, businesses generally have to take out a mortgage to pay off the cost. The factors determining whether you will be approved for an investment property loan are somewhat different and demanding. Commercial mortgage lenders will look at many financial aspects to decide such as property appraisal, credit check, the down payment, and the Debt Service Coverage Ratio.
Hire a Property Appraisal
You will need a professional property appraisal to determine the market value of the commercial building and accompanying land. The real estate appraisal keeps the lender from inadvertently loaning you more money than the property is worth, thereby reducing the risk of loss for the lender.
Appraisals are also conducted for residential home purchases, but the price-deciding factors are different. The value of a commercial property is based not only on the condition of the roof, plumbing, and other systems, but also depends on the size, location and accessibility of the place.
Demonstrate a Good Credit Record
With an investment property mortgage loan, you will also need to demonstrate a good credit record. Certainly, good credit score is a bonus in residential mortgages, but commercial properties generally cost higher than the residential properties, and therefore, the credit requirements tend to be more stringent.
Additionally, Checking your credit history and score, lenders will require plenty of income and asset documentation to ensure you will be able to make your mortgage payments. If it is your own business that will occupy the business space, then the lender will want the proof of the profitability of your venture.
Commercial real estate financing will depend on where the property is located and what you intend to do with it. Consult with your tax advisor about how you plan to use the real estate property to decide whether it would be better to buy an investment property.
Understand the Numbers
Investors have different goals. Some may want to buy an office, fix it up and sell it quickly to get huge profit. Others specialize in land, which means they put a contract on a commercial property in a development before it is constructed and then, sell it for a profit, sometimes before they complete the purchase.
Whichever you decide to take, make sure you understand the numbers, such as financing cost, a down payment, advisor fees, repair, etc. Be practical about whether you can afford to make the mortgage payments as long as you find a tenant or buyer.
Decide the Down Payment
Down payments are another determining factor in whether or not you will be approved for a commercial property financing. The big price tags on business properties make lenders very cautious as the risk is much higher. Large down payments are generally required for an investment property mortgage loan, with the minimum being 20 percent of the price. In many cases through, the average seems to be a down payment of 30-45 percent.
You are then provided with the loan of the remaining amount of the purchase price. The amount you are loaned compared to the actual price is called Loan to Value Ratio (LTV) and it is commonly used percentage in the mortgage field. When you come up with 10% down on your first investment purchases, there are loans now that allow for 100% financing on investor properties.
Many loan programs allow sellers to contribute toward the closing costs to help minimize your out-of-pocket expenses. Another possibility is to secure your down payment with funds you have in brokerage account. When the investment property achieves 25% equity, the lien on the account is released and the pledged amount plus accrued interest is once again completely under the borrower’s control.
Even if you have cash for a down payment, you may not want to tie it up in your new property. For instance, you can open a certificate of deposit (CD) with the lender using his down payment funds and still borrow 100% of the purchase amount. When investment property achieves 25% equity, the lien on the CD is released and the CD, plus accrued interest, is returned to you.
Either cases, 100% financing is achieved. These options are also available to investors who want close and hold title in a business entity, limited instead of in their personal name in order to protect their assets.
Debt Service Coverage Ratio
Finally, you will be approved for mortgage based on the Debt Service Coverage Ratio (DSCR) of the commercial real estate. This the amount of money the realty generates each month from rents and other fees (the net cash flow)versus the amount of the monthly mortgage payment (the debt service). The ratio helps lenders to determine how much you can reasonably afford to pay on your commercial property loan each month.
Most like to keep the ratio between 1.1 and 1.4. A ratio of 1.4 means that for every dollar you pay in mortgage payments, your property should be generating $1.40. your revenue would therefore be larger than your debts, and you would theoretically be able to repay your loan.
So, you find out all possibilities, here are some steps you need to take to make things more clear and move smoothly:
Do the Paperwork
You will be asked to provide copies of your financial documents, including two months’ worth of your bank statements, investment account and retirement account statements, last two pat stubs if you have a regular paycheck job, driver’s license and social security case; bankruptcy, divorce or separation papers, if applicable. If you are self-employed, you will be asked to provide following documents- business license or occupational license, , two year’s tax returns, business bank statement and business financial statements.
Assemble Your Team
You will need an accountant who understands investment property tax strategies, a real estate attorney who can help you make sure you use property contract and the right contingencies. You will also require a mortgage professional who has extensive experience in investment properties, an attorney who understands asset protection to help you build the proper structure for holding your investment property, and an experienced insurance agent as well.
Experienced advisors can help identifying problems before they actually happen such as holding investment property in your name, etc .
Before you start searching for commercial real estate property, get pre-approved loan through a mortgage broker or lender, and request it in writing. Never sign a contract with a finance waver without pre-approval.
How will You Meet the Loan Repayment Terms?
Generally, bank requires the borrower to repay entire business loan earlier than its defined due date. Banks do this by requiring most of their loans to include a balloon repayment. If the business happens to have any cash-flow issue, the lender may require a high interest rate, or the borrower may not qualify for a loan at all. In this situation, the borrower runs the risk of being turned down for financing altogether and the property may be in jeopardy of foreclosure.
Non-bank lenders or private bank lenders generally offer less stringent credit requirements for commercial loans. Such lenders will make a long term commercial loans without requiring the early balloon repayment. These loans, which may carry a lightly higher interest rate, work like a typical home loan. Lenders allow a steady repayment over twenty or thirty years. Often times, it is worth paying a one or two point higher interest rate for a fixed term loan to make sure the security of a long term loan commitment.
How Much Can or Should You Borrow?
Most bank loans prohibit second mortgages, so the borrowers should go into the loan process intending to borrow enough to handle current business requirement. For a conventional acquisition loan in which the borrower is buying a new property, banks usually require a down payment of 20-25%.
Many non-traditional loans allow the borrower to make a smaller down payment, maximizing the loan –to-value at 85-90%. If the customer wants to borrow the maximum amount possible, the interest rate on such loans may be point or two higher than typical bank loans.
Before deciding how much to borrow, you should evaluate how much cash they are likely to need, analyze their ability to repay the loan as it is structured.
Be sure to shop around and ask each lender how he or she determines its approval. You can be competitive in the commercial property loan market by doing your homework and coming fully prepared to the negotiating table.
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