Buying Commercial Or Industrial Property – Lender Risk Assessment Know-How
Commercial & Industrial Buildings – New Zealand
It is a popular misconception that the same lending ‘rules’ apply when bank and non-bank lenders assess the risks associated with commercial and industrial properties, as they use with residential loan applications.
In fact, there are many differences between the risks associated with commercial and residential lending which necessitates completely different lending criteria.
LEVEL OF DEBT
One of the biggest differences is the level of debt that the lenders will allow borrowed against commercial property. While it is relatively common for lenders to borrow up to 80% of value, with some lenders going up to 90 or 95% on residential properties, the norm for commercial property is 60 – 65% of value. There are some lenders who would look at 75 – 80%, but this would depend on the lease profile and collateral security.
This means that there is a much greater requirement for larger amounts of available equity in order to purchase a commercial or industrial property.
TENANTS
The main reason for this conservative approach by lenders is the ‘tenant risk’. Tenants for commercial and industrial properties are businesses with their own set of risk factors.
Some obvious factors that need to be taken into consideration are:
Length of time the tenant has been there Length of the lease
Lenders consider the length of a lease to be a major factor when assessing the lending risk. They will not favour short term leases, where there is the risk of the tenant moving out leaving a vacant property, which would seriously affect the properties cash flow and the ability to service the debt.
But other factors are also important:
What type of business is the tenant? How long have they been in business? Their financial strength What is the future of the business, i.e. Is it a business sector with a future?
As property owners will probably not have access to the financial accounts of their tenants, lenders will use the length of time the tenant has been in business and how long they have been a tenant, as an indicator of their financial strength.
Tenanting a commercial property is not as easy as residential as the demand is even more dependent on location, along with the design and flexibility of the building to meet the requirements of the tenant business.
LOCATION
The one factor that remains the same for both commercial and residential property when assessing risk profile is the location. Good commercial locations, especially those in city centres, will carry less risk to capital protection, value growth and tenant demand, than those in less desirable locations such as regional towns or rural locations.
DEBT SERVICING
The Debt Servicing Criteria is also very different when compared to residential properties. For commercial properties, the rent received will be related to a multiple of the cost of debt. This currently equates to a multiple equal to 1.5 times the debt cost i.e. Loan of $1,000,000 at 7% = $70,000 – therefore rental income needs to be in excess of $105,000 Per annum.
INVESTING IN COMMERCIAL OR INDUSTRIAL PROPERTY
Commercial property can be a good investment if you understand the risks associated with this type of asset and the manner in which the Banks assess the risk.
Our key recommendations:
[1] Before you make an offer to buy a commercial or industrial property enlist experts in this area; including legal, accountancy, commercial property agents, financiers – all who understand this market to ensure you get the best possible advice before you make a commitment to invest.
[2] Research, know and understand likely tenants, their industries, location and local activity, and all associated ongoing financial commitments.
By: Gary Hey
About the Author:
Author: Gary Hey, Mortgage People Ltd Auckland New Zealand.