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2. Lower Loan-To-Value Ratios on Commercial Loan = Larger Deposits
Whilst residential borrowers can borrow up to 90% (or even 95%) of the value of the property (LVR) - Commercial property loans are generally capped at 75-80% LVR. This means that you would generally either need a larger deposit or be able to access more equity.
3. Shorter Loan Terms
A typical residential property loan term is 30 years, whereas for commercial property it is generally between 15 to 20 years. The consequence of this is that borrowers will need to show a lender a greater capacity to repay, as the repayments will be higher as the principal will need to be paid down in a much shorter time frame, even if it is partly interest only. You need to show a stronger serviceability in regards to your pay slips, rental income on other properties and lease agreements, compared to the LVR you are planning to borrow and your other financial obligations.
4. Different Lease Terms
There is a variety of commercial lease terms and some leases can provide benefits and incentives that can enhance an applicant’s loan application, e.g. the length of lease and outgoings being paid by tenants.
Most residential leases last between 6 to 12 months. Commercial properties, on the other hand, are subject to longer term leases – ongoing 3+3 years or 5+5 years with options to extend for another 3 or 5 years. Tenants in commercial properties are also more likely to pay their own outgoings such as water, rates and land taxes. This can sometimes factor favourably into your loan application as it can evidence a greater ability to service the loan.
5. More Fees = More to Borrow
Commercial loans have higher valuation fees which usually need to be paid up front. Just like when you apply for a mortgage on a residential property, a lender will need to order a valuation when you apply for a commercial property loan. Whilst residential property valuations are generally done for free, most lenders will unfortunately pass on the cost of a commercial property valuation to you.
For commercial properties under $1 million, this can cost between $800 and $1,500. For properties over $1 million the fees will be higher and in addition professional valuers will typically charge you a much higher amount depending on the lender, location of property and type of property.
Depending also on yours and the vendor’s GST status, some sales of commercial property might attract an additional GST cost.
In summary, financing a commercial property isn’t much harder than applying for a regular mortgage, though keep in mind that:
• You will need to show a greater capacity to repay a commercial property loan given the shorter loan terms of between 15-20 years; and
• You will need a higher deposit/equity because you will generally only be able to borrow up to 70-80% of the value of the property.
• And of course, finding the right mortgage broker to give you more loan options can also make a very big difference.
Thinking about buying a commercial property? Read our tips and learn about how commercial property loans work and what you can expect in commercial property interest rates.
Long term eases
Commercial property leases usually run for longer periods than residential properties – several years rather than 6 to 12 months. This gives you greater certainty of rental income, plus rents tend to be reviewed annually. However, vacancy periods can be longer.
The impact of GST
Goods and services tax (GST) applies when you buy a commercial property, so allow an extra 10% on the property’s purchase price. As an investor, you can claim the GST back as an ‘input tax credit’ against GST charged on the property’s rent.
The lessee pays maintenance costs
Unlike residential property, the costs of maintenance, rates and repairs on a commercial property are paid by the lessee – not the landlord. This means more of the rent you receive goes towards your profit. However, be sure your commercial lease spells out who is responsible for the property’s ongoing expenses.
Some commercial properties serve a limited purpose
It can be harder to secure a lessee on a property that’s designed for a specific purpose. Opting for a property with multi-use appeal can help you attract a broader range of tenants.
As with any property investment, location plays a big role in the success of commercial property. Look for an area offering good transport links, a nearby pool of workers, and surrounding businesses that could offer support to lessees.
Could a commercial property deliver better rental returns?
Commercial property is usually regarded as a higher risk asset than residential property, and reflecting this, the rental return is usually higher. However, the decision between investing in residential or commercial property is a personal choice that will depend on the investor’s financial circumstances, goals and willingness to take on this higher risk investment.