Purchasing Commercial Property: What’s Different from a Residential Loan?
For seasoned investors, the transition to commercial property is often the natural next step. For those wishing to purchase a commercial premises to occupy for their business operations, a commercial purchase is a strategic investment which makes sense from a business perspective.
For both types of purchasers, stepping into the world of commercial property will immediately feel different to residential property. Commercial assets, whether industrial warehouses, retail shopfronts, or office spaces; can offer higher rental yields, longer leases, and greater security of tenure.
For owner occupiers, purchasing a commercial premises can provide stability, removing the need to deal with landlords, increasing rents, and restrictive lease terms.
However, securing finance for a commercial property is a completely different landscape to buying a house. The rules, risks, and assessments change significantly. Whether you are growing your investment portfolio or securing a permanent home for your business, here are the key differences you need to understand.
1. The Deposit and LVR Limits
In residential lending, we are comfortable and familiar with borrowing up to 80%, 90%, or even 95% (plus or including LMI) of the value of the property.
Commercial lending is a little more conservative. Commercial properties are viewed as higher risk due to a more limited market of buyers and potentially longer vacancy periods. We don’t like quoting commercial LVRs as they are unique to each different scenario. A very general guide would be 65% - 75% for investors, depending on the lender and the proposal.
For owner occupiers, there are options to borrow well above this threshold. This saves them injecting too much capital into the purchase, thereby allowing them to continue operating their business effectively. Depending on your financial strength and the type of asset you wish to acquire, higher LVR solutions may exist:
Higher LVR Commercial Loans: Some niche lenders may allow up to 90% LVR for strong applicants who meet certain criteria, enabling you to purchase with a smaller deposit.
Leveraging Residential Equity: It may be possible to fund up to 100% or more of the purchase price by utilising equity in a residential property as additional security.
These high-LVR options are not available with every bank. They often come with specific conditions regarding the loan purpose, amount, and loan term (such as accelerated amortisation being imposed on a portion of the debt), so it is critical to compare the total cost of the structure before proceeding. Case-by-case only.
2. How the Property is Valued
This is one of the biggest differences. The valuation method depends entirely on the purpose of the purchase.
For Investment Purchases: Valuers prioritise the income-producing ability of the property. The primary method used is the Capitalisation of Income approach, where the valuer assesses the net rental income and applies an appropriate market capitalisation rate (yield). This calculation determines the property's value based on the certainty and strength of the income stream. Key factors include tenant quality, remaining lease term (WALE), rent review mechanisms, vacancy risk, and the broader market demand.
For Owner-Occupied Purchases: The focus shifts to the physical attributes and market comparable sales. Valuers rely primarily on the Direct Comparison method, analysing recent sales of similar properties to determine a fair market value. Building size, land size, condition, location, zoning, layout, parking, and suitability for the intended business use all play a significant role. As no third-party rental income is involved, the income approach is generally used only as a sense-check and not a valuation driver.
3. The Importance of the Lease (WALE) for Investors
In residential, a 12-month lease is standard. In commercial, leases are set over several years with options to extend.
Lenders will look closely at the WALE (Weighted Average Lease Expiry), usually excluding options. They want to see that the remaining lease term covers a significant portion of the loan term. If a property has a tenant whose lease is coming up to the end of its term, lenders may view this as a high vacancy risk, potentially reducing the amount you can borrow, increasing the interest rate, or both.
4. Interest Rates and Terms
Residential rates are highly standardised and mainly tiered based on the LVR. Commercial rates are largely risk-based. The rate you are offered depends on:
The strength of the borrower
The quality and location of the property
The length of the lease/s (for investors)
Vacancy rates (for investors)
The LVR
Facility terms (including establishment and ongoing fees) can vary considerably from lender to lender. Commercial property loan terms can be quite short, particularly if the loan term is determined by the WALE. However, depending on your requirements and the purpose of the loan, there are many lenders now offering loans up to 30 years. This simply reinforces how every lender is different, and every proposal is assessed on its own merits.
5. GST and Going Concern
Unlike residential property, purchasing a freehold commercial asset often attracts Goods and Services Tax (GST). However, if the property is purchased with an existing tenant or tenants in place, it may be classified as a "Going Concern," meaning GST may not apply to the transaction. This is a critical area where your accountant and solicitor must be involved before you sign a contract.
Final Thoughts
Commercial property can be a powerhouse for your financial future, whether purchasing strictly for investment purposes or owner occupation. However, the lending landscape is complex and negotiated on a case-by-case basis.
You simply cannot shop around and compare rates online. You need a strategic finance professional who has a good relationship with the lenders, understands how to present your business case, and can negotiate terms to suit your cash flow.
Contact Imperium Finance to discuss your commercial purchasing strategy today.