Commercial Mortgages

Lenders divide commercial mortgages into two categories and underwrite them quite differently.

Owner occupied

This is a business buying the premises it trades from: a workshop, a surgery, a shop with a flat above, an office, a nursery. The lender is lending against your trading performance, and the property is the security rather than the source of repayment. Terms are generally better than on investment lending because the occupier and the borrower are the same, so there is no tenant risk. Many businesses buy through a pension scheme, and a SIPP or SSAS purchase is worth exploring with your adviser before you commit to a route.

Investment

This is a property bought to let to a commercial tenant. Here the lender is assessing the lease, the covenant strength of the tenant, the unexpired term and how easily the unit would re-let if the tenant left. A single let unit on a short lease to a small business is a harder proposition than a multi let estate with staggered lease expiries, and it will be priced accordingly.

You will normally need two to three years of filed accounts, plus up to date management figures if the year end is some months behind. The lender works from adjusted profit, usually earnings before interest, tax, depreciation and amortisation, and adds back anything that is discretionary or one off, such as directors’ remuneration above a market salary.

The key test is the debt service cover ratio. That is the profit available to pay the debt, divided by the total annual mortgage payments. Most lenders want somewhere between 1.25 and 1.4, meaning the business needs to generate 25% to 40% more than the loan costs. Where a business is growing, or the purchase replaces rent, a forecast showing the effect of the move can materially change what a lender will do, provided it is supported by the numbers.

Expect personal guarantees from the directors, often capped at a percentage of the loan, and a debenture over the company. Lenders will also look at how the business banks: consistent, well managed accounts with no unauthorised borrowing carry real weight.

Deposits generally start at 25% to 30% for owner occupied premises and 30% to 40% for investment purchases. Specialised property with a narrow resale market, such as a petrol station or a care home, will need more, because the lender is pricing the difficulty of selling it if things go wrong.

Terms usually run from five to twenty five years, and repayment is normally on a capital and interest basis. Interest only is available on investment cases but rarely for a full term. Rates are commonly quoted as a margin over the Bank of England base rate or over SONIA, and fixed rates are available from many lenders, typically over shorter periods than on residential lending.

Budget for the transaction costs, which are heavier than on a residential purchase. There will be an arrangement fee of around 1% to 2% of the loan, a valuation you pay for up front and which can run into four figures on a commercial property, your own legal costs and the lender’s legal costs, and in some cases an environmental or building survey. A commercial case commonly takes eight to sixteen weeks from application to completion.

Commercial mortgages are generally unregulated. The FCA’s mortgage rules are written for people borrowing against their own home, and they do not extend to a business borrowing against its trading premises or an investor buying a commercial unit. In practical terms that means the consumer protections you would have on a residential mortgage, including access to the Financial Ombudsman Service, may not be available.

There are edge cases. A mixed use property where you or a family member live in part of it can fall under the regulated regime, depending on how much of the property is residential. We will tell you which side of that line your case sits on before you commit to anything.

The quality of the initial submission affects the answer you get, so it is worth assembling this before we approach anyone:

• Two to three years of full accounts and the latest management information
• Recent business bank statements, usually six to twelve months
• Details of the property, including tenure, condition, use class and any leases in place
• A summary of what the business does, how long it has traded and where the income comes from
• Personal asset and liability statements for the directors, with their own credit position
• Forecasts where the purchase changes the cost base, for example where a mortgage payment replaces rent