Business owners that outgrow their own at-home office have two main options. The first is to rent a premises that helps them grow their business. The second is to own it. Now, you may find that renting your commercial locations continues to be the right approach for you. There is nothing wrong with letting a commercial property, especially if you have big expansionist plans.
There are, however, instances where buying your commercial property is just the right move for your business. You may be a property investor, might need to develop a specific commercial property for your business needs, or may want to buy now to avoid paying increasingly higher rent prices.
Before you jump into a commercial mortgage, however, it’s important to know what a commercial mortgage is, the different types, and what sets a commercial mortgage apart from a standard residential mortgage.
What is a Commercial Mortgage?
A commercial mortgage is a type of secured loan that’s used to buy commercial properties. This means it can be used to buy a retail shop, a warehouse, or even a manufacturing plant, but it cannot be used to buy a rental property.
Confusingly, you would, however, need a commercial mortgage to buy or develop an apartment building or mixed-use property.
If you are confused about the difference, here’s a breakdown:
- You’ll need a buy-to-let mortgage to rent out a single flat or home
- You’ll need an HMO if three or more unrelated tenants live in a single property
- You’ll need a commercial mortgage if the building has multiple units contained in it.
What is a Commercial Mortgage Used For?
What is a commercial mortgage used for, exactly? While you now know the type of properties you can buy with a commercial mortgage, it doesn’t explain why you’d want to buy one over renting.
In general, those in the UK use commercial mortgages to:
- Purchase a commercial property for their own use (business owner)
- Acquire commercial properties to rent out to other businesses (investor)
- Extract equity from commercial properties you already own for any other reason (business owner/investor)
Types of Commercial Mortgages
There are two main types of commercial mortgages. If you switch how you use your commercial property, you will need to switch commercial mortgages.
· Owner-occupied commercial mortgages
If your goal is to operate out of the commercial property you buy, then you’ll need an owner-occupied commercial mortgage. You can buy retail stores, manufacturing plants, warehouses, or a property specific to your business use with this mortgage type.
· Commercial investment mortgages
If you want to buy a commercial property and then rent it out, you’ll need a commercial investment mortgage. This also applies if you intend to buy an apartment building to rent out to residential tenants.
Similar Mortgages for Commercial Investments
However, those two commercial mortgages aren’t the only ones you may want to consider when looking to secure your commercial property. You also have:
· Bridging loans
A bridging loan can be used to secure a commercial property if you can’t wait for your mortgage application to go through. You’ll need to be very confident your commercial mortgage will go through when applying for a bridging loan or have another source of money coming through to pay for the new property, as bridging loans only last between 12 to 18 months at most.
· Development finance
If you plan on specifically developing a new property (buying land and building on it or refurbishing an old or disused property), then you will want to look into a development finance commercial loan.
How Much Can You Borrow?
How much you can borrow largely depends on the loan to value of the property, how profitable your business is, and your expected debt service coverage ratio (DSCR).
· Loan to Value (LTV)
Loan to Value (LTV) refers to how much the loan would cover of the commercial property’s value. Commercial loans tend to cover far less than residential properties, even if commercial loans are also secured loans.
In the UK, most lenders only offer commercial mortgages for up to 70 to 75% of the property’s value. You’ll usually need to make the rest up via the deposit.
· Deposit
You’ll need at least a 25% deposit, if not more. The higher your deposit, the more likely you’ll get more favourable loan conditions.
· Profitability
How profitable your business is will be another factor. If you are consistently making money and have a strong plan to expand your business with the purchase of the property, include that in a business plan. You’ll need to add at least three years of financial records along with your business plan to help convince lenders of your profitability.
· Debt Service Coverage Ratio (DSCR)
DSCR is used to help businesses understand how well they can take on mortgage debt. You will need to calculate the DSCR and compare it to what you expect your monthly mortgage payments will be.
- DSCR between 0 to 0.9: This DSCR means you are already in debt and cannot make repayments. You will not get a loan with this amount.
- DSCR of 1.0: If you have a ratio of exactly 1 that means you have zero cash flow and are just floating. You won’t be able to get a loan with this ratio.
- DSCR between 1.01 to 1.25: This is a slightly profitable business. You may be able to get a commercial mortgage, but the interest rate would likely be higher.
- DSCR between 1.26 to 2.0: You are a profitable business and can take on the additional debt of a mortgage. You’re more likely to get mortgage offers with more attractive interest rates.
- DSCR over 2.0: If your DSCR is over 2, then you’re a very healthy business and have a strong negotiating position. You’ll likely find it easier to find favourable commercial mortgage options.
How to get a commercial mortgage
We’ve put together a more in-depth guide on how to get a commercial mortgage to help you better understand the steps involved. The process is, however, similar to getting a residential mortgage. What’s different is how you prove your business’ profitability and how well you can afford the mortgage.
