Types of Commercial Mortgage

A commercial property mortgage is focused solely on the physical premises being funded, a bricks and mortar valuation is required to assess the Open Market Value of the property itself. The type of property mortgage is divided by lenders into those that will be used by the borrower, and those that will be tenanted out – the former being the Owner Occupier commercial mortgage and the latter, the Commercial Investment Mortgage

1. Owner-Occupier

With this loan, the borrower will need to demonstrate serviceability of the loan from business profits and therefore business accounts will be needed alongside proof of any additional income or secondary security which may be offered.

In instances where the borrower is proposing to move from rented business accommodation to a freehold property then any rent and other property related expenses incurred in the rented accommodation will be treated as an ‘add back’ when calculating the serviceability of the loan. The same logic applies when buying an existing freehold if the business has been renting their premises to date.

Lenders will also wish to deduct
(i) any existing loan commitments
(ii) Dividend payments in order to arrive at a figure which is used to assess the serviceability of the proposed commitment.

Lenders will normally start by using the ‘earnings before interest tax and depreciation more commonly known as ‘EBITDA’ in addition to the ‘add backs’ and ‘deductions’ as detailed above in order to assess serviceability.

An example of this calculation is:

Operating profit + Existing profit + Depreciation = A
Existing loan/HP commitments + Dividend = B
A minus B = The surplus cash to be used for serviceability analysis

All lenders would wish to see the proposed annual mortgage commitment covered between 125-160% on a fully amortising basis. However, there are a few lenders who will offer interest-only facilities for owner-occupiers.

2. Commercial Investment

If the loan is to purchase a commercial property on an investment basis then the affordability will be based on the rental income from the property as verified by an independent surveyor as typically lenders will not lend on vacant commercial property.

As this income is being paid by a third-party tenant the covenant of the tenant, the length of the tenancy agreement and the break clauses within the leases will be looked at in depth.

If the borrower has other property or income, then again it may be possible to take these into consideration as additional security and proof of serviceability of the loan.

In terms of serviceability, lenders would wish to see the annual commitment covered by the rental income by between 125-160% on an interest-only basis and between 125-140% on a capital and interest basis. Generally, the higher the serviceability requirement the lower the interest rate.

Some Tier 2 lenders allow for interest-only facilities for the full term. Some allow for 60% of the vacant possession value to be on an Interest-only basis, with any borrowing requirement up to 75% loan to value being repaid over the term of the facility which is restricted to 10 years.

An example of serviceability:
(a) Annual Interest costs = £10,000
Lenders serviceability cover requirement = 125%

Therefore, the minimum rental income being generated from the target property needs to be £12,500 per annum, which also needs to be confirmed as the minimum market rent.

(b) Annual Capital and Interest cost = £16,000
Lenders serviceability cover requirement = 125%

Therefore, the minimum rental income being generated from the target property needs to be £20,000 per annum which also needs to be confirmed as the minimum market rent.

Lenders will also wish to know the following
(i) Length of the lease or remaining term
(ii) Whether the lease contains any break clauses and if so the dates
(iii) Is the lease a fully repairing and insuring lease, more commonly known as FRI lease?

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