Commercial mortgages may be taken out by businesses owners, in which case they are ‘owner-occupier’, or used by professional investors to purchase commercial property to be let out, in which case they are known as investment mortgages, or ‘commercial buy-to-let’ mortgages.
Owner-occupier mortgages
Borrowers are generally businesses, or business owners, who intend to use the property in the normal course of their business operations. However, not every business will be able to access commercial mortgage lending, as some of the pre-requisites will typically include a multi-year trading history, consistent profitability, and cash reserves sufficient to fund a 20-40% deposit.
High Street banks often have the most stringent eligibility requirements – Barclays requires business borrowers to provide three years of audited accounts, management accounts for the current year, two months bank statements, and a balance sheet. The businesses’ credit record will also be considered, and the lender will conduct a stress test of the borrower’s ability to finance the loan if interest rates were to rise substantially from prevailing levels. This can be especially relevant since commercial mortgages are typically variable rate.
These requirements will change according to the lender (and may also include a business plan with financial projections), and there are alternative and specialist lenders who will fund new businesses or those with poor credit ratings – though at higher interest rates, lower LTV ratios, and evidence of industry experience by senior personal, or personal guarantees from the business owners. However, accessing mortgage finance can still be a challenge for many small businesses.
Investment mortgages
Third-party investors take out commercial mortgages to buy business premises to rent out to companies, who will occupy and use the property. Much like in the residential market, investment mortgages are considered higher risk by lenders, and will typically attract higher interest rates and lower maximum loan-to-value (LTV) ratios. The mortgage approval is based on the lender’s assessment of the rental income that is expected to be generated by the property, considering factors such as location, features and usage restrictions.
Typically, lenders will expect to see rental coverage of at least 125% of the mortgage payments, and preferably substantially more. For obvious reasons, lenders also prefer properties to have existing tenants, preferably on multiyear leases, and ideally engaged in activities not excessively dependent on the economic cycle.
Other commercial mortgages
In addition, there are other niche types of commercial mortgage, including development loans and bridging finance. Development loans are used to develop, renovate, or refurbish properties which are unfinished, derelict or uninhabitable. They are typically shorter duration, from several months up to a few years. They are released in tranches as the development proceeds, which means the developer is only paying for the capital they need at the time.
Users of development loans vary from individuals seeking to refurbish a single-family house, to professional real estate developers. Bridging loans are another kind of short-term loan, used to fill gaps in cash flows – such as between buying one property and selling another to finance it.
An experienced commercial mortgage broker will be able to recommend the best mortgage to suit your needs and circumstances. You can find the best-rated UK commercial mortgage brokers in our commercial mortgage broker directory.
