PB-190 Timely Tips on Finance - Property Inc

[ Podcast Transcription ]

I’m Peter Bonamignis and he is Chris Lane and welcome to another of these regular property briefings.

And a warm welcome to you, Chris. Once again, it is good to be here. I’m assuming most of our listeners have at some point organized a residential loan, which is generally fairly straightforward. How might applying for a commercial loan be different? Well commercial property finance is one of the aspects probably least understood by investors which will cause them to make rather poor decisions.

The most important thing you need to grasp is that there are basically no hard and fast rules about the various factors involved like the leverage that’s available, the costs associated with a commercial loan, or the… actual lending criteria most financiers seem to adopt. And when it comes to commercial finance, everything has to be viewed in relation to the strength and the size of a particular deal.

So why are things different for a commercial loan? As you mentioned, most people are pretty Used to understand residential mortgages where a lender will offer a set rate and charges plus different amounts of leverage depending on the location of the property. Servicing is calculated by taking into account all the debts and sources of income attributable to the borrower and any guarantors if that’s required.

And there are some commercial lenders who operate in a similar manner. Generally, these lenders only deal with smaller transactions in restricted geographical locations. The main point here is that residential lenders tend to price most deals the same way, with some possibly discounting for larger loans.

While perceived risk is the factor dictating whether they will fund you or they won’t. And it has little or no bearing on the actual price of the loan itself. On the other hand, commercial lenders place much greater emphasis on the aspect of quantifying risk and will apply different lending ratios depending on the risk that they perceive for a particular security.

However, they could also adjust pricing according to the Similar factors as with residential. Therefore, two loans of the same size may be significantly different in terms of pricing for a commercial property. Obviously, risk assessment is important. What are some of the factors influencing that? Lenders look at a wide range of characteristics and factors when determining the risk level for a transaction, and some of these include the financial strength of the borrower, the experience of the borrower with that type of property and its location, the term of the lease itself, the financial strength of the tenant.

Any guarantees which are attached to the lease. Some of the key clauses in the lease, such as market reviews, the current strength of the local market, the overall economic conditions at the time, the lender’s view of the geographic location and type of property, and also possible alternate uses for the property.

And also whether your plan to hedge against interest rate movements. And also the lending ratio that you’re seeking. So it’s a bit of a mixed bag and it’s very hard to predict because each deal is viewed on its own particular characteristics. And as I said, the size of the deal and the various other components related to the tenant and the lease.

Okay, taking all that on board, how can it affect the interest rate charged for your commercial loan? Well, unfortunately the answer is significantly. And the precise way in which different lenders price risk is proprietary knowledge. That they tend to guard fairly closely, and therefore it can vary markedly between lenders.

And as a result, larger loans with low perceived risk can be priced at very close to residential mortgage rates, whereas smaller deals, but with a higher risk factor, will often attract a higher And this is where using a broker is important because over time the brokers will start to interpret the profile of each lender, whereas if we are doing it individually, we don’t do it often enough to be able to understand particular idiosyncrasies each financier has.

So That, more or less, begs the question, how do you ensure a good interest rate? Basically, you need to follow the similar steps that you would in choosing a property intended to provide you with a good long term return. And these are that you purchase quality properties which would easily release if they became vacant.

You also purchase properties with sufficient time length on the lease to allow a reasonable loan term, preferably at least three years. Now if it’s a long lease, just make sure there are regular market reviews so that you aren’t left with an asset. That is under let for a long period. Make sure that you have a good tenant with security.

This can be achieved by personal corporate guarantees, which depending on the tenant are good. I mean, a guarantee from say, Coles or a substantial company is good. I much prefer to have bank guarantees or significant funds in bond or trust to provide a good security against a default by the tenant. But a bank guarantee is best because you have unfettered right to call that up if the tenant does default.

Also, look at As I said, financially strong tenants which are attractive to lenders for this reason if you can get a publicly listed company or at least a subsidiary of a publicly listed company, it’s always going to appear better to lenders. Also properties with several alternate uses are generally perceived to be a lower risk.

than a specialized property, so that I tend to steer away from child care centers, medical centers, etc. because Most, or many of them, are in a residential zoning, but they have a commercial use and therefore if the occupier up and leaves, you’re constrained in who the replacement tenant can be. Also, where the asset is of a specialized nature, it’s important that you have a very strong demand for that style of property, plus the quality of the tenant and the lease is also more important in such circumstances.

And I guess finally, a strong rental return, providing for a significant coverage of the interest cost. And that’s one of the key things a financier looks at. Well, I’m sure that’s been really helpful for our listeners, so thank you. Look, with a commercial loan, you do have to jump through a few more hoops, but the secret is to engage a good mortgage broker who can guide you every step of the way.

And that will remove most of your anguish and make everything a whole lot easier. As I said, that’s really great. So thank you, Chris. It was my pleasure.