A handy guide for financing a business purchase or commercial property
Are you thinking of borrowing to buy a business or commercial property? Perhaps you were wanting purchase an industrial property in your SMSF or were considering developing over 4 dwellings in a residential property development? This guide ought to help answer your questions.
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If you are using your home as collateral and are putting money into an existing business or accredited franchise system, you may be able to finance up to 100% of the value of your property as a business equity loan.
Example: A business owner has a home valued at $900,000 and has a home loan for $450,000. If his business is profitable and he can prove that the loan will be used for a sound business purpose, up to $450,000 may be accessible as a business loan.
This is effectively borrowing 100% of the value of your property. It is worth noting that most mainstream business lenders will only allow for a maximum of 70% of the business purchase price to be granted as a loan without additional collateral being offered as security for the loan.
Is it possible? Yes, as long as you have additional security for the loan. Normally this is the investor’s home or an investment property.
Example: An investor wishes to purchase a commercial property that is worth $1,000,000 with no deposit.
However, they own a residential property worth $700,000 with $250,000 remaining on the loan. Lenders will potentially allow the $450,000 equity in the residential property to be put towards a deposit for the commercial property.
This increases the Loan to Value Ratio (LVR) on your residential property, bringing it to 100% of the value. The remainder of the funds may then be borrowed on the commercial property.
It is important to note, however, that the maximum LVR of commercial real estate purchases is typically 70 to 80%. If the commercial collateral is large scale industrial or a commercial ‘working farm’, the maximum LVR may drop as low as 50%.
Short answer: Yes.
Better answer: These types of loans are generally limited 65% LVR and, due to NCCP Act considerations, must fall outside of lending that is protected by the NCCP Act.
The assessment of a business loan is similar to that of a standard home loan. There must be adequate security, sufficient income to repay the loan, and the borrower needs to have a relatively solid credit history with no unpaid defaults.
In addition to these basic requirements, there are some unique aspects of the loan that are also assessed:
- Cash out: Financial institutions consider equity releases or “cash out” to be a high risk for most business loans.
- Directors’ experience: Financial institutions prefer to see owners or directors who have experience in their industry. If a director/owner does not have experience, it is likely that residential security will be required for the loan.
- Purchase of a business: Although there may be financial statements confirming the businesses’ current income, there is no guarantee that the new owner will get the same results. Therefore, lenders are conservative when assessing this type of application.
- Start-up businesses: Financial institutions may consider lending to a new business if there is a solid business plan, cash flow projection and the owner has experience in the same industry. Start-up business loans must always be fully secured by property.
- Working capital: Borrowing to expand a current profitable business is the preferred type of business loan for lenders. These loans are generally considered to be low risk, as there is already a proven income and tested business model.
- And much more: The assessment of business loans is complex and cannot be covered in a handful of bullet points. Seek professional independent advice before engaging in business loans to ensure that you are aware of and understand all the requirements and processes.
There are three main factors that assist in getting the cheapest possible equity loan to release funds for use in small business:
- Apply with the right lender: The first mistake that most people make is to approach their current bank to get a business loan. The key to getting a low rate is to find a lender that will assess your commercial loan as a home loan.
- Use your equity in residential property: Residential property such as a house, unit or block of land is an excellent security for a loan. It can be accurately valued and sold quickly in the event of a default. Commercial properties are difficult to value and generally take a long time to sell, therefore tend to attract higher interest rates.
- Use 100% secured loans: If your loan is not completely secured, then the rate may be much higher or the loan may be declined. If you are borrowing more than 90% of a residential property or 70% of a commercial property, then your loan poses a very high risk.
Using either property or a fixed and floating charge over business assets, you can potentially borrow:
- Up to 95% of the value of your residential properties (in isolation). With 80%LVR considered a ceiling for easy approval in most scenarios.
- Up to 100% of the value of the proposed purchase price (when cross-collateralised).
- Up to 80% of the value of a commercial property. With 60%LVR considered a ceiling for easy approval in most scenarios.
- Up to 70% of a going concern’s or accredited franchise’s greenfield valuation using the lender’s valuation methodology.
- The loan must be predominantly for business purposes, as this category of loan is unregulated.
- You must be buying a commercial property, buying shares or investing money into a business.
- Typically you must own residential property that has sufficient equity in it.
Note: Lenders may require that you take out a second mortgage, or other registered charge against your residential property. You may also have to refinance your existing loan to the lender.
A common question is why do financial institutions charge more for a loan that is used for business purposes? A number of variables factor into this pricing:
- Higher risk to the lender: When starting up a new business or purchasing an existing business, there is a higher risk of default compared to when purchasing a property and taking out a standard home loan. However, if the existing business has a proven track record, this risk of default is reduced.
- The application assessment process takes more time: Lenders can easily assess home loan applications using quick automated methods such as credit scoring. However, when assessing a loan for a business, the lender needs experienced credit managers and business bankers who are often expensive.
- Lack of competition: The majority of customers take out a commercial loan with one of the four major banks. Due to the lack of competition in the commercial finance market, many borrowers are simply unaware of the cheaper options and discount packages elsewhere.
The team at Naritas are experts in delivering timely guidance & finance approvals. We have over 100 lenders on our panel & a high quality team of dedicated advisers to steer you efficiently through the approval process.