Commercial mortgages can be complex.
When a business reaches a certain level of success, it’s natural to consider purchasing commercial office space, instead of leasing.
Sure, a lease tenant isn’t responsible for maintenance or repairs and can deduct the entire amount of rent as a business expense on their taxes… but that business also doesn’t build equity, add to its portfolio of capital assets, or boost creditworthiness in quite the same way.
Plus, rent is an unpredictable expense over time, since it can increase with each renewal.
When compared long-term, leasing is substantially more expensive.
(This QuickBooks article does a nice job of outlining the benefits of leasing or buying).
If you plan to remain in the same location for at least eight years, purchasing office space can be a very smart move, saving tens—even hundreds—of thousands of dollars annually.
Before moving forward with a loan application, here are ten important details a savvy borrower should be aware of:
- They can afford a substantial down payment, which typically ranges from 10 to 30 percent of the purchase price. It’s often far more than the security deposit leasing requires. If making the down payment puts a business’s cash reserves in jeopardy, it might not be the right time to consider a commercial mortgage.
- They are prepared for unexpected expenses beyond typical closing and move-in costs, such as legal fees, surveys, appraisals, due diligence and inspection fees, insurance, build-out costs to adapt the space, and other surprise expenses that inflate out-of-pocket costs. Smart borrowers are prepared to cover these along with the down payment.
- Commercial mortgage terms typically last from 15-to-20 years, and they are able to remain in one location for at least 6-7 years to justify the purchase. A borrower should be very confident they won’t outgrow the space they are purchasing during that time.
- They’re ready to put pen to paper (or talk with their banker) to ensure this is a profitable decision, and have a clear goal in mind. Are they buying as an investment or simply to save money for the business? Are they planning to become a landlord and rent out unused space? Are they thinking an office condo is the best fit? Strategically thinking through what they’d like to accomplish by purchasing a commercial space, talking to a professional and running the numbers (in projected good times and bad) ensure a smart decision before commitment.
- They’ve considered the “opportunity cost” of a new commercial mortgage. What potential opportunities are they giving up by choosing not to invest that down payment and other out-of-pocket costs into another area of the business?
- They’ve thought beyond closing costs. Are there enough cash reserves (or available credit) to handle major repair costs, not just normal maintenance? If an expensive plumbing or wiring issues happens, or multiple air conditioners go out at the same time, how will those costs be covered?
- They know the lowest interest rate isn’t always the best deal. Different loan terms can impact cash flow, so length of the loan is just as important as the interest rate. For example, a $250,000 mortgage with a 20-year term at six percent interest results in a $1,650 monthly payment, but that same loan amount with a lower interest rate of four percent for a shorter term (15 years) will cost almost $200 more per month. Amortization, balloon payments and adjustable interest rates also make a huge difference, so an educated borrower will calculate the actual payment on different loan packages. They also consider cash flow and profitability when crunching numbers, not just interest rates.
- Smart applicants don’t give up if declined on a loan application, because one bank’s decision is not every bank’s decision. Each bank has its own criteria and decision maker opinions can vary, so an application declined at one bank might be approved at another. Community banks also typically approve more loans than big banks, due to their reliance on the local community.
- If a loan is denied because the property value is less than the loan amount, smart borrower’s rethink the purchase decision. If lenders tell a borrower that the loan is bad, savvy business
people don’t ignore common sense and pursue private money at exorbitant interest rates. They put emotion aside to acknowledge red flags, listen to professional advice, and consider alternatives.
- They seek non-recourse loans, so that if default on the loan should occur, the lender is limited to repossession of the property and cannot pursue additional damages from the business.
Commercial and residential mortgages are very different. Their loan structures, risks, terms and contracts vary, even from one commercial mortgage package to another. It’s important to thoroughly understand options, and invest time learning the basics.
If you are new to commercial mortgages and less than confident about your knowledge, or just smart enough to always seek the advice of experienced professionals for critical transactions, we are standing by to help. Give us a call or stop by a branch today!