Businesses that are in search of commercial property have some very important choices to make early on. Depending on the type of company and its actual space and location requirements, business owners have to first decide if they want to lease or buy real estate.
In hot real estate markets, it can be a challenge to find the right spot to lease at an affordable price, and this is true whether you’re in search of office buildings to house your employees or a warehouse to store your goods.
The difficulty is raised even higher if you want to purchase a business property, mostly because of the costs involved. Buying commercial real estate requires a large capital investment and the implementation of a property maintenance program that is not necessarily part of a company’s core business. This forces some companies to decide that leasing is the best option.
In both cases, leasing and buying real estate, acquiring all the funds you need to secure the deal may require you to take out some form of commercial real estate loan. Real estate loans can be complicated, but in most cases, they are absolutely necessary.
Read on below to learn more about how you can qualify for a commercial real estate loan, and continue growing your business for years to come.
Commercial Real Estate Loans 101: The Basics
Because the value of a commercial real estate loan is usually so much higher than the value of a residential mortgage loan, there are a number of qualifications a business must satisfy for banks and lenders. The bar can be set quite high.
For example, a lender is going to want to know about the type of business you run. Very often, the terms of a commercial real estate loan will depend closely on the nature of your company and the type of property required.
A bank or other lender will also want more information on your current business situation. Even those with existing, profitable businesses will need to provide historical financial statements, a business plan and detailed financial projections so the bank or lender can feel confident you can make your payments.
Your business situation will help define your risk profile, which is a major factor in determining not just the size of the down payment, but the overall terms of the commercial real estate loan.
Business Risk Profiles
A risk profile (and the related interest rate lenders charge) will be determined by a number of other factors as well, including your credit score and credit history, as well as your business’ debt service coverage ratio.
Debt to Service Coverage Ratio
This is one of the most important criteria that lenders look at, and is essentially a calculation of your net operating income divided by your annual debt servicing costs.
DSCR = NET OPERATING INCOME / ANNUAL DEBT SERVICE COSTS
For example, if your business makes a net operating income of $100,000 per year, and your annual debt service cost is lower than that number, your debt service coverage ratio will be higher than 1. A ratio of 1 or higher is a strong indicator that a business is making enough operating income to cover its annual payments. A bank or lender will often consider businesses with a debt service coverage ratio of 2 (or higher) to be an ideal borrower.
Loan to Value Ratio
Another risk assessment tool used by banks and other lenders is the loan to value ratio. This is calculated by dividing the mortgage amount by the appraised property value, and expressed as a percentage.
LTV Ratio = Mortgage Amount / appraised property value
For example, if you were to spend $20,000 on a down payment for a property valued at $100,000, the loan to value ratio would be 80% ($80,000 the amount borrowed divided by $100,000).
A high loan to value ratio is considered high risk, and low loan to value ratio is considered a low risk. Banks and lenders that provide a commercial mortgage to a business with a low LTV ratio will be able to offer a lower interest rate, since the risk is considered lower. On the other hand, a high LTV ratio will, in some cases, require that the business purchase mortgage insurance. Banks and lenders can usually provide the lowest possible interest rate to borrowers with LTVs of 70% or less.
Higher Down Payments Than Residential
Finally, unlike residential mortgages, you should expect to face higher down payments for commercial mortgages, anywhere from 20% all the way up to 50%. For mixed residential and commercial properties, the down payment will be on the lower end of that scale, but for “pure” commercial properties, the down payment will likely be 30% or greater.
Why Do I Need a Commercial Real Estate Loan?
Commercial real estate loans can be useful to cover the costs of securing a new commercial lease, or they can be used to buy commercial real estate outright. However, these are not the only two reasons a business may be interested in a property loan.
Commercial real estate loans can also be used by business owners that own their property, interested in renovating an existing property of theirs. The cash can be used for anything, including modernizing their equipment to stay competitive, hiring new employees, outsourcing projects overseas to lower costs, or simply using the money to get through a difficult period.
More Details on Commercial Real Estate Loans
As mentioned above, banks and lenders will refer to a number of factors to determine your risk profile, and what level of financing options they can offer you. Let’s get a little bit more specific.
How is Commercial Real Estate Priced?
The costs of buying or leasing commercial real estate are typically expressed per square foot.
How Long are Commercial Loan Terms?
Commercial real estate loans often have repayment terms of between five and ten years, but amortized (paid off) over a term of 25 years. This will often require a balloon payment at the end of the term one that can be difficult to pay if not properly planned for.
Once Purchased, Can I Lease Part of My Building to Other Businesses?
Commercial real estate loans are designed to purchase a property or finance its improvement. Yes, you can lease part of your building to another business. Be sure to verify market leasing rates to ensure you are generating reasonable revenue from the space you are leasing out. It is also important to verify the covenant of the other business that you are leasing space to. This will provide some comfort that they will be able to meet their lease obligations for the term of the lease. Be sure to use a good commercial lease, preferably one that is verified by your legal counsel. This revenue counts as revenue generated to help meet the Debt to Service Coverage Ratio on the property.
How to Prepare for My Commercial Real Estate Loan Application
This can be a long and difficult process. Proper preparation will require you to get together certain documentation, and bankers and lenders often will need some of the elements laid out below before they can offer you loans.
- Tax returns (up to five years)
- Credit reports for business and all partners
- Projected cash flow statements
- Historical financial statements
- An appraisal of the property (done by a third party as well as the bank)
- Your business plan (detailing property use, strategy, management expertise, etc)
Obviously, with these types of requirements, it will be easier for established businesses to get loans, as opposed to new business.
Should I Lease or Buy Commercial Property?
There are risks and benefits to both buying or leasing commercial property. And while everyone’s business and financial profile is unique, risk and opportunity levels will also be affected by region, in that some areas are extremely competitive and pricey, and others less so.
Because each situation is unique, the decision about whether or not you should get a commercial real estate loan will usually always depend on your specific situation.
The best advice we can give is to reach out to a local commercial real estate company that specializes in commercial leases, and find the best possible price you can. Once you’ve done that, explore the costs of buying a commercial property outright, and choose the option best for you.
Where Can I Find the Best Commercial Real Estate in Ottawa and the National Capital Region?
If you’re still in the exploratory phase and want to acquire a commercial space for your business in the Ottawa or surrounding areas, Merkburn Holdings is a great company with which to exchange ideas.
Merkburn Holdings have been in the business for over 50 years, and manage close to one million square feet of commercial and industrial space in the region, including offices, warehouses, manufacturing facilities, showrooms and more.
To learn more about renting or leasing space, consult their blog about the ins and outs of how to rent commercial office space. Merkburn specializes in helping their tenants grow, and can even help them renovate or expand their properties to accommodate growth.
However, if you decide that neither leasing or purchasing a commercial space is the right move for your company at this time, you can also explore options related to co-working spaces. Merkburn owns and operates a new co-working space in Kanata, Catalyst, which just might be the perfect option for you!
Get in touch with them anytime by calling (613) 224-5464, or emailing them at email@example.com.