The strategy To borrow to buy commercial property.
Do I need to do that? Many investors find commercial property – whether it’s an office, shop, warehouse or industrial property – is a good way to diversify their property portfolio.
Commercial property can also have other attractions.
Rental returns tend to be better than on residential investments and the tenant pays most of the outgoings, whereas landlords tend to foot all the bills with residential property investments. But these benefits can be outweighed by the significant costs incurred in borrowing to buy commercial property.
Because they view commercial property as more risky than residential, you’ll generally need more equity with a commercial loan as well. While residential property buyers can usually borrow up to 95 per cent with mortgage insurance and 80 per cent without, the maximum loan-to-valuation ratio for commercial loans is usually 75 per cent and the majors are generally comfortable with 65 per cent to 70 per cent.
And as if that isn’t enough, a commercial loan will cost you more, a loan application fee of 0.75 per cent is not unusual and there are also valuation, legal and ongoing fees. While you might pay a $600 application fee on a residential property, the application fee for a $500,000 commercial loan could be as high as $3500 and with valuation and legal fees on top of that you’d be lucky to get change from $5000.
Ongoing fees vary – some are 0.2 per cent a year, others $8 or $15 a month, others again about $300 a quarter – and the interest rate on a commercial loan is also higher.
As a guide would be 7 per cent versus 5 per cent for residential finance and the terms on commercial loans can also be prohibitive. Some lenders, for example, require annual reviews, which basically means you have to front up and justify your borrowing every year.
Ouch! Are all lenders this expensive? Yes. He says some smaller lenders will offer better deals like ING Bank are offering fixed rates 0.8% higher than residential rates and IMB for example, will lend for 25 years and ING has a good commercial loan if you meet its strict lending criteria. Macquarie Bank is also excellent at looking at the big picture.
The big banks are more flexible in their approvals process, but you pay for it.
If you can, it is much cheaper to use residential property as security for a commercial property purchase, as this will reduce the costs and increase your options.
This could either be done through a home equity loan (if you have enough equity in your home and are comfortable using it as security for an investment) or by putting up other residential properties as security.
Will lenders make it easier for me by allowing me to pay interest only? You will get a better deal if you can use residential property as security with Residential rates and fees, borrowers can usually negotiate up to 10 years interest only on a 30-year loan but the interest-only period for commercial loans is usually only the first five of the standard 15 years.