Whether you are a start-up business or a seasoned property investor, financing commercial property can be a daunting process. With so many options to choose from, it is important to identify what type of funding is right for you and your business.
In this article, our commercial property solicitors explain some of the primary reasons you may need to use commercial property finance and explore the various options available. We also consider purchasing a commercial property as an individual or through a limited company, and what it means to provide a personal guarantee.
When is commercial property finance commonly used?
Commercial property finance is most commonly used to purchase new business space, such as office buildings, retail units or warehouses. If you are ready to grow your business but can’t afford to buy outright, commercial property finance can help you fund the purchase.
Purchase of a trading business that has a physical property eg: hotel or travel agency
Commercial property finance is also commonly used to purchase a business that trades from a physical premise e.g. a hotel, restaurant or travel agency. In this case, commercial property finance funds the purchase of the business itself and the property it occupies.
Release equity built-up in your current property
You may be able to unlock any positive equity built-up in a commercial property you own and use it elsewhere. You can release equity through re-mortgaging your property with additional borrowing or by taking out a second-charge mortgage – an additional loan on top of your existing mortgage.
For refurbishments or development of an existing property
You can also use commercial property finance to cover the costs of works to improve or modernise an existing commercial property. This could be anything from funding minor renovations to a complete upgrade.
How do you finance the purchase of a commercial property?
A commercial mortgage is a loan that is used to purchase or refinance a property that is used for business purposes.
Types of commercial mortgage
In theory, owner-occupied commercial mortgages are not too dissimilar from residential mortgages - instead of buying a home to live in, you are buying commercial premises for your business. You might find yourself using this type of commercial mortgage to buy your first business workspace, relocate or expand.
- Commercial buy-to-let
This type of mortgage is designed for investing in commercial property with the intention of renting it out to business tenants. This may be a good option if you are looking to generate a steady income stream.
- Residential buy-to-let (as part of a property portfolio)
This type of mortgage allows you to finance multiple rental properties with a single loan. Here, lenders look at the overall value of the properties in the portfolio and the rental income they generate, rather than evaluating each property individually. This can make it easier to qualify for financing and manage properties.
Process of applying for a commercial mortgage
Once you have identified a suitable lender, you will be asked to complete an assets and liabilities statement and provide several documents about you and your business. This is likely to include proof of identity, bank statements, business accounts and tax returns. Lenders will arrange a property valuation and perform due diligence checks before issuing a formal mortgage offer.
Qualifying criteria for a commercial mortgage
These vary by lender and product but in general, you can expect to make a contribution of anywhere between 20% and 40% of the property’s value. Lenders will want to see proof of your ability to repay the loan by reference to your trading history, business accounts, and financial forecasts. The property’s potential rental income may also be taken into account.
How long does it take to get a commercial mortgage?
Timeframes vary depending on the type of commercial mortgage you take out and your unique circumstances. A straightforward, owner-occupied mortgage might take several weeks to process, but it may be several months before funds are released.
Advantages and disadvantages of using this approach
Using a commercial mortgage has several business benefits, including:
- Stability and control: you enjoy the perks of owning a commercial premises without paying your hard-earned cash as rent to landlords, or worrying about unexpected rent increases
- Lower interest rates: interest rates are often lower compared to other unsecured business loans and are also tax-deductible
- Built-up equity: any monthly capital repayments towards the loan will reduce your debt / increase your equity in the propertyLong-term investment: the property may appreciate in value over time
- Profit: any rental income may cover mortgage payments and provide a profit
As with most things, there are also some disadvantages including:
- Long process: the application process can be long and complicated, requiring you to gather and provide a significant amount of documentation and information
- Large upfront payments: larger deposits are usually required for commercial mortgages, or if lower deposits are accepted, you may end up paying higher interest rates to compensate
- Property loss: if you are unable to make the mortgage payments, you risk losing the property and any goodwill in the location
What is bridging finance and when is it used?
As the name might suggest, bridging finance is a type of short-term loan typically used to ‘bridge funding gaps’ before moving on to a long-term solution. It is commonly used to secure commercial property quickly while waiting to receive proceeds of sale of another property. You can also use bridging loans to finance a property renovation project, buy property at auction, or simply get a quick cash injection for your business. The loan can last anywhere from a few weeks to 12 months.
What is the process of getting a bridging loan?
Applying for a bridging loan can be relatively straightforward in comparison to standard mortgages. Some lenders offer a decision in principle within 24 hours of receiving a completed application, but in most cases, it takes around two weeks to release funds. Your application is likely to include your personal and business details, details of how much you wish to borrow and why. The loan will be underwritten, property valuations obtained and legals completed before funds are released.
Qualifying criteria for bridging loans
While exact requirements may vary, most lenders will look for the same overarching criteria. In particular, lenders will want to see you put down a reliable physical asset to secure the loan against (most often one or several properties). They will also want to see a clear exit strategy to repay the loan. This could be selling the property purchased using the loan, refinancing with a long-term loan, or even calling in any outstanding debts.
Advantages and disadvantages of using bridging finance
The advantages of using bridging finance include:
- Speed: it can be arranged relatively quickly, often within a matter of days
- Flexibility: it can be used for a variety of purposes, and lenders may be more willing to accommodate your particular situation
- Access to funding: it is not always necessary to have a good credit rating or a long-term income stream to secure bridging loans
- Cash flow: repayment of the interest and amount borrowed is not due until the end of the term, which can help with cash flow
Disadvantages of using bridging loans include:
- Higher cost: it is generally more expensive than traditional forms of lending, with higher interest rates and fees
- Short-term solution: it is designed to be repaid quickly, typically within a few months to a year, which can be challenging if you need more time to secure long-term financing
- Property loss: if you cannot keep up with your repayments, the lender may repossess the property you put up as collateral
What is asset-based lending and when is it used?
Asset-based lending at its simplest is a loan secured by an asset, which is put up as collateral to guarantee the loan’s repayment. Common company assets used include accounts receivable, real-estate, existing inventory, and machinery. A property you intend to purchase can itself be used as collateral for the loan.
Asset-based lending can help you secure finance fast, such as to cover an unexpected short-term gap in revenue. In the property sphere, asset-based lending is often used to purchase and ‘flip’ dilapidated property.
What does the process look like?
Asset-based lending involves a thorough evaluation of the asset you intend to serve as collateral. The lender will then offer a loan amount based on a percentage of the asset’s value.
Qualifying criteria for asset-based finance
Eligibility criteria may vary, but lenders typically focus on the asset’s value over your creditworthiness as a borrower. This is because lenders can recover their monies by repossessing the asset should you default on the loan. Naturally, you will also have a big incentive to avoid defaulting and risk losing your valuable business asset. If the collateral is dilapidated property, lenders look at its current value and likely value after any major works are undertaken, as well as its potential for generating income.
Advantages and disadvantages of using asset-based lending
Some of the benefits of using asset-based lending include:
- Access to funding: it may be a suitable alternative when traditional lending criteria are not met. This can be particularly helpful if your credit history is not great or you have an inconsistent income
- Faster and easier: it typically requires less paperwork and offers faster approval times compared to traditional lending methods
There are also disadvantages to using asset-based lending, such as:
- More expensive: it may come with higher interest rates compared to traditional lending methods, which can increase the overall cost of the loan
- Loss of asset: if you find that you are unable to make regular payments on the loan, you risk losing valuable business assets
- Risking future loans: given the looser eligibility criteria, future lenders may view a history of asset-based loans negatively. Limiting the value and number of asset-backed loans you take out can help mitigate this
Sale and leaseback
How does sale and leaseback work?
Sale and leaseback works by selling a commercial property you own and occupy to a buyer, then leasing it back from them. You will no longer own the property, but will still be able to continue using it for your business.
When should you consider this option?
If you have any tied-up capital in an existing commercial property you run a business from, sale and leaseback may be a good option to enable you to access and use the funds.
What is the sale and leaseback process?
The process is not too dissimilar from the sale and purchase of commercial property. You will need to identify a willing purchaser and appoint solicitors to conduct the conveyancing. The main difference is, the purchaser agrees to simultaneously lease the property back to you on the day of completion. You remain in occupation and your business is not interrupted.
Advantages and disadvantages of sale and leaseback
As with every financing option, there are pros and cons. Some of the main benefits of using a sale and leaseback arrangement include:
- Access to capital: you can access capital that was previously tied up in your property as soon as the sale completes. You can use the funds as needed, whether that's to fund business operations, an expansion, or pay off debts
- Fixed lease payments: the lease agreement typically has fixed payments, which can help you with cash flow management
- Tax benefits: lease payments are tax-deductible
The main disadvantages of sale and leaseback are:
- Loss of ownership: you will no longer own the property, and cannot use it as collateral for future loans
- Higher lease payments: lease payments may be higher than any commercial mortgage payments
- Uncertainty: the lease agreement may include provisions for rent increases, which can impact your business's profitability in the long term
Private equity is a less common but viable method of raising capital to fund commercial property. It involves securing investment from private individuals or firms, who in return get a percentage share in the equity of the property.
There are several steps involved in private equity finance. Firstly, you will need to identify potential investors and present a detailed plan outlining the property's potential for growth and profitability. Investors will conduct their due diligence checks to satisfy themselves of the property's potential, then both parties will negotiate the terms of the agreement. This will detail the amount of equity the investors will receive and the expected return on investment.
Pros and cons of this approach
One of the main benefits of private equity financing is that it allows you to raise funds without putting up collateral or going through a lengthy application process. Private equity investors are also typically more flexible than traditional lenders.
One of the main drawbacks is that it can be more expensive than traditional financing methods. Investors may require a higher rate of return on their investment to compensate for the higher risk involved. Another potential downside is that private equity investors may have more control over the property's management and operations, which compromises your independence and autonomy.
Timescales can vary depending on the complexity of the transaction and the number of investors involved. However, the process typically takes several months from start to finish.
Purchasing a property under a limited liability company
There are important differences to consider when deciding whether to purchase a commercial property in your name or through a limited company.
As a sole trader
If you are a sole trader, you are personally responsible for all of the debts and liabilities of your trade. If you purchase commercial property in your name and your business fails, you could potentially lose your personal assets to cover the outstanding loan.
As a limited company
A limited company is a separate legal entity from its owners, with responsibility for its own debts and liabilities. As such, if you purchase commercial property through a limited company, your personal assets will not be compromised in the event of business failure (however see note below about personal guarantees).
From a financial viewpoint, this offers greater protection to you but there are additional costs, legal and administrative requirements involved in setting up and running a limited company.
Ultimately, the decision to purchase a commercial property as a sole trader or through a limited company will depend on your individual circumstances. Our expert commercial property solicitors can help you make the right decision for you and your business.
Personal guarantees are often required in commercial property finance, especially if you are a small business or new venture without a strong financial track record. This is because the guarantee provides an additional source of repayment to lenders in the event of default, and increases their confidence in lending.
It's important that you fully understand the implications of a personal guarantee before agreeing to it. If your company defaults on the loan and the lender calls in the personal guarantee, you will be personally responsible for repaying the outstanding debt. This can potentially put your personal assets at risk, including your home and savings.
There are some steps you can take to mitigate the risks associated with personal guarantees, such as:
- carefully review the terms of the guarantee and note any default triggers, such as missed payments or breaches of loan covenants
- negotiating with the lender to limit the scope of the guarantee, set a cap on the amount, or release the personal liability once your business is more stable
- taking out personal guarantee insurance or director's and officer's liability insurance
Ultimately, providing a personal guarantee is a significant decision that should not be taken lightly. Our commercial property solicitors can carefully review guarantees and seek to negotiate any onerous terms for you.
In conclusion, whether you are purchasing, refinancing or renovating a commercial property, there are many funding options to consider, each with its own risks and benefits. It is important to identify which option is right for you and your business early on to protect your investment. Speak with one of our commercial property lawyers today to determine the best course of action for your specific circumstances.