At the end of 2010 there were estimated to be about 5.2 million Commercial properties in the UK – an expansion of 32% over the last decade. Despite the economic downturn and gloominess, the credit crunch is often not visible when you visit a commercial property auction. In the last five years, commercial property deals increased by £7.7 billion, according to the Bank of England. So how are people acquiring so many commercial properties? The answer is with a commercial loan or a commercial mortgage. It appears leverage is still available for the right deals in the commercial world.
In simple terms, a commercial mortgage is a loan taken out using a commercial property rather than a personal property as security. How much can be borrowed? Typically a LTV of 70-75% can be available, though unsurprisingly this figure has dropped in recent years. The Lender will also be keen to look at the Borrower’s ability to repay so producing a well-kept set of business accounts for a minimum of three years is also a necessity. If it is shown that the business is unlikely to generate the cash flow to meet interest and capital payments then the Bank will prudently weigh this against the Borrower. In addition sometimes the loan may also need to be secured with personal guarantees, depending on the covenants of the Borrower. On the plus side, interest payments are chargeable against profits for the Borrower providing a strong tax advantage to profitable Borrowers and terms can be extended up to 25 years, much like a residential mortgage. Not all lenders will offer this type of loan though; only a commercial lender who specialises in commercial property loans and it certainly pays to use a specialist broker and shop around.
So what’s the difference between this and the other commonly used term a commercial loan? The answer lies in security. A mortgage, by definition, is secured against a property whereas a loan, doesn’t have to be, though often is. The loan allows more flexibility, can be used for a wider variety of purposes and, of most importance to a rapidly expanding business, can be set up quickly whereas a mortgage will require detailed valuation reports and legal documentation to be drafted. There is a difference too in rates and term. Unsurprisingly, because the mortgage is secured on a property it likely comes at a better interest rate – a reflection of the reduced risk for the Lender – and it generally can run for up to 25 years whereas the loan will probably be a revolving facility capped at 5 or 7 years.
Choosing which one is best is a matter of tailoring the requirements of the business. A mix of both is likely to be present in any business with the mortgage providing a backbone of long term funding supplemented by a revolving loan facility. Either way the key thing to be conscious of is the ability of the business to repay. Defaulting on either is unpleasant, whatever the terms used!
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