A borrower’s guide to the commercial mortgage market

[3 mins read]

 

In the same way the High Street shops have been sidelined by their online competitors, so too have the UK’s High Street Banks when it comes to commercial lending and the new wave of non-bank competition.

According to the Cass Business School’s annual UK CRE Lending Report, for the first time last year, the biggest chunk of lending within the commercial investment market came from non-bank lendersA company or person that lends money to another. and non-UK banks, who claimed 55.8% of the £49.6bn market.  A huge piece of the commercial pie, and a dramatic shift for both the UK’s domestic banks and their loyal borrowersThe person, persons, or commercial entity applying for the Loan from the Lender..

It’s fair to say that post-2008 crash and even in the last couple of years, the commercial lending market has fragmented substantially.  There are now dozens of lendersA company or person that lends money to another., and without expert guidance it’s a tricky market to browse, let alone shop.

 

Here’s our definitive guide to borrowing in the commercial mortgageThis term is usually used to refer to mortgages secured against Commercial Investment Properties. Commercial Mortgages need to be supported by the income earned by the asset. The lender will deduct the operational expenses from the Gross Income to calculate the Net Income of the asset. It is the Net Income which the lender will then stress test against internal covenants (Stress Rate, Amortisation Profile) to determine what level of loan they can support. For example: Gross Income = £ 100k, Lender Gross to Net = 85% (£ 85k), Stress Rate = 6.5%, Rental Covenant = 125%, Amortisation Profile = 15 years, therefore Possible mortgage = £ 650,513. market.

 

What is a commercial mortgageThis term is usually used to refer to mortgages secured against Commercial Investment Properties. Commercial Mortgages need to be supported by the income earned by the asset. The lender will deduct the operational expenses from the Gross Income to calculate the Net Income of the asset. It is the Net Income which the lender will then stress test against internal covenants (Stress Rate, Amortisation Profile) to determine what level of loan they can support. For example: Gross Income = £ 100k, Lender Gross to Net = 85% (£ 85k), Stress Rate = 6.5%, Rental Covenant = 125%, Amortisation Profile = 15 years, therefore Possible mortgage = £ 650,513.?

A commercial mortgageThis term is usually used to refer to mortgages secured against Commercial Investment Properties. Commercial Mortgages need to be supported by the income earned by the asset. The lender will deduct the operational expenses from the Gross Income to calculate the Net Income of the asset. It is the Net Income which the lender will then stress test against internal covenants (Stress Rate, Amortisation Profile) to determine what level of loan they can support. For example: Gross Income = £ 100k, Lender Gross to Net = 85% (£ 85k), Stress Rate = 6.5%, Rental Covenant = 125%, Amortisation Profile = 15 years, therefore Possible mortgage = £ 650,513. is a loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More against a commercial propertyAn asset, normally to be held for the long-term and to produce an income, and / or Capital Growth. Examples include; Hospitality (hotels), Retail (shops), Leisure (pubs), Student Accommodation, Medical (GP Surgery), Light Industrial (Shed / Logistics), Heavy Industrial (Manufacturing Plant), HMO (House of Multiple Occupancy; e.g. Bedsit), Office, Care Home / Retirement and Educational (University / Private School). that is owned by an investor to generate income (or capitalThe value of a financial asset in monetary terms. See Capital Value. appreciation), or by an owner occupier to use as their place of work.  This encompasses everything from retailAs a Commercial Property type this refers to properties used as shops of any kind; e.g. grocery, clothes, opticians, etc. and office space, student accommodationProperty developed exclusively for the use of students. Normally large blocks of apartments, organised as pods or communal living. We use it in Commercial Property and Development Finance to classify the use class., hotels and care homesAs a Commercial Property type this refers to a residential building, where older people live, normally in single rooms with communal areas and on-site care and support services., to industrial warehousesUsed as a description of a property class in Commercial Property. Think of the huge storage Warehouses and logistic centres used by supermarkets and online retailers. Also known colloquially as a 'Shed'., schools, universities, pubs, restaurants and hospitals.

 

How is a commercial loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More calculated?

Commercial loansWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More are calculated using the net income that a tenantA person that occupies a property owned by somebody else, and pays rent for that privilege. produces, or the net income of the business if it is owner occupied, to calculate an affordable loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More amount.  In essence, the loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More works backwards; operational expenses are deducted from the Gross IncomeThe total income earned in return for a good or service., to assess the Net Income of the assetAn item of property owned by a person or company, that has a value and could be used as Security for a Loan..  The Net Income is then tested against stress rateThe rate at which a lender tests their loan against. This is used for assessing loans against Income-Producing Assets (BTL & Commercial Property) This is a rate that will be higher than the loan Pay Rate, the idea being that Interest Rates or Cost of Funds will increase in the future, and should this be the case the lender wants to ensure that the loan is still serviceable by the income earned. and amortisation profileThis is the term to which the payment schedule is set against. Commercial Mortgages are often offered for a term of say 5 years or 10 years, however the repayment profile is extended past the loan term. A typical example would be a 5 year mortgage term with a 15 or 20 year amortisation profile. to determine the level of loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More affordabilityRules applied by a Lender to determine what is a sustainable level of Mortgage for a Borrower to support. With Residential Mortgages a Lender will rely almost solely on a client's income and expenditure to make this calculation, and clients should expect to complete a Monthly Budget Plan. Lenders will take a proportion of the surplus income and then work backwards from there, probably at a Stressed Rate, to determine what Loan the Borrower can qualify for. For BTL, a Lender will take the rental received, deduct a percentage to allow for maintenance, voids and tax, and then look for the remaining rent to cover a higher Stress Rate..

 

Which lendersA company or person that lends money to another. should I consider?

Whilst all lendersA company or person that lends money to another. will underwrite a commercial loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More using the methodology described above, they will all have different rules, so it’s hugely important to shop around to uncover the best deal for you.  Borrowers’ personal circumstances are less relevant for commercial loansWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More, but you’ll find huge variations when it comes to other criteria.

 

For example, some may discount income from tenantsA person that occupies a property owned by somebody else, and pays rent for that privilege. or ignore it completely if they think they are not a strong covenantA contractual stipulation in a Loan Agreement which needs to continually met, so that the loan does not fall into Default. Cure Rights may apply. If the Loan continues to be in default for a period of time, then the Lender may exercise their rights to recover their loan..  They will also have different requirements for how much cover is needed and the rate they want to stress at to decide the final loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More, so sticking with a tried and tested lenderA company or person that lends money to another. may mean missing out on a better deal elsewhere.

 

Here are the types of lenderA company or person that lends money to another. we recommend talking to before choosing your loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More:

 

LenderA company or person that lends money to another. Type	Pros	Cons	Need to know
Mainstream banksA collective term used to apply to the mainstream UK Mortgage Banks. Generally good for simple loans up to £ 1m. Above £ 1m there may be better options in the Private Banking or Specialist Lender sectors. Also known as High-Street Lenders or Retail Banks / Lenders.	Cheaper interestRegular payments made by a Borrower to a Lender in return for the money that has been lent to them. Tracker (base or LiborOr London Inter Bank Offer Rate is the rate at which banks agree to lend to each other at on a wholesale basis. There is normally a time period attached to it to confirm the borrowing term; e.g. overnight, 1 month, 3 month, 6 month, etc. The most typically applied rate is 3 Month Libor. It is used a lot by Private Banks, in Commercial Mortgages and Development Finance as their Cost of Funds.) or fixed ratesWhere your Loan Interest Rate remains the same for a defined period. The best option for borrowers that want certainty of the borrowing costs. Fixed rates normally attract Early Repayment Charges if broken before the defined period finishes, so you should be certain you want to retain that asset for at least that period of time. normally available	Low average LTVThe ratio of debt to property value, expressed as a percentage; for example a Borrower that obtains a Loan of £ 6,000,000, against a property value of £ 10,000,000, would be expressed as 60% LTV. : 60%-65% Amortization profile of 15-20 yrs (although may allow 12 months interestRegular payments made by a Borrower to a Lender in return for the money that has been lent to them. only) Slow processing and decision-making	May need company bank accounts to move as part of the deal
Institutional lendersA company or person that lends money to another. e.g. pension fundsA scheme that provides retirement income, but also a Lender of monies against Property. We use the term Specialist Lenders to cover any non-Mainstream Banks, of which Pension Funds would be one./insurance companies	Normally cheaper than High Street banks, especially on fixed ratesWhere your Loan Interest Rate remains the same for a defined period. The best option for borrowers that want certainty of the borrowing costs. Fixed rates normally attract Early Repayment Charges if broken before the defined period finishes, so you should be certain you want to retain that asset for at least that period of time. Long-term fixed ratesWhere your Loan Interest Rate remains the same for a defined period. The best option for borrowers that want certainty of the borrowing costs. Fixed rates normally attract Early Repayment Charges if broken before the defined period finishes, so you should be certain you want to retain that asset for at least that period of time. as standard (5-40 yrs) No PGs (normally)	Low average LTVThe ratio of debt to property value, expressed as a percentage; for example a Borrower that obtains a Loan of £ 6,000,000, against a property value of £ 10,000,000, would be expressed as 60% LTV. : 60%-65% Less likely to offer tracker ratesWhere your Loan Interest Rate moves in line with the Cost of Funds Index that it is tracking. Typically a Variable Rate consists of the Cost of Funds (e.g. Base Rate or Libor), plus the Lender Margin. Whilst the Lender Margin is normally fixed for a defined period of time, the Cost of Funds can fluctuate meaning the total Interest Rate charged can also change. Also known as a Floating Rate. (but can) Prefer amortisingAlso referred to as paying Capital & Interest. Each month part of the payment is assigned to servicing the Interest, and the rest is used to reduce the Capital. As Capital payments are made, the outstanding Capital balance reduces. Therefore the portion of the payment assigned to interest reduces, and the portion assigned to Capital repayment increases. If you have a Fully Amortising Loan then providing all payments are made are made in full and on time, then the mortgage debt would be fully repaid at the end of the mortgage term. loansWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More Slower processing	Normally £10m is min. loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More.  More choice from £20m+
Challenger banksThe UK banking sector has historically been dominated by the 'Big Four' of; HSBC, Barclays, Lloyds and RBS Group. Newer entrants have concentrated on areas that are underserved by the more established players, such as; Development Finance, Commercial Mortgages for SME's and Residential Mortgages that cannot be easily automated (such as those for older applicants or the self-emploted). Challenger Banks include; One Savings Bank, Metro, Oak North, Aldermore, Shawbrook and Starling. Although their loans are more expensive, you are less likely to get a 'computer says no' as loans have more manual underwriting input than the Big Four (in our opinion).	High LTVThe ratio of debt to property value, expressed as a percentage; for example a Borrower that obtains a Loan of £ 6,000,000, against a property value of £ 10,000,000, would be expressed as 60% LTV. : up to 70%-75% Offer interestRegular payments made by a Borrower to a Lender in return for the money that has been lent to them. only repayments, so good for maximising cashflowThis refers to the inflows and outflows of cash within a business. In Development Finance to project the Build Budget / Build Costs over the Build Term. This is important as when Borrowers require monies to fund the build, and when they expect to sell the properties at the end, directly affects their profit; the greater the distance between the two variables increases the cost of funding the project. Lenders generally assume equal draws of the Build Loan across the Build Term; e.g. if you have a Build Loan of £ 1m, and a 10 month Build Term, the Lender will assume that £ 100k is drawn every month for the Build Term. This is wholly unrealistic, and as a result means that the cost of the funding is skewed. By providing an accurate projected Cashflow at the outset, and keeping it up to date through the build, will only help you to actively monitor (and hopefully reduce) your funding costs. Faster decision-making and processing	Higher rates	Will normally be more flexible with their underwritingThe process of assessing a Loan Application and deciding whether the Lender wants to make a Loan to the Borrower. See Underwriter. approach
Debt funds	High LTVThe ratio of debt to property value, expressed as a percentage; for example a Borrower that obtains a Loan of £ 6,000,000, against a property value of £ 10,000,000, would be expressed as 60% LTV. : up to 70%-80% Significant in-house expertise for large & complex loansWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More Faster decision-making and processing No PGs (normally)	Higher rates	Minimum loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More is £10m Happy to lend globally so gives more flexibility for multi-jurisdiction clients
Mezzanine	Enable additional borrowing power up to 80%-85% dependent on income	More expensive, but with the lower cost of the senior debt, the blended rate between the two products can still be very attractive Additional admin by dealing with two lendersA company or person that lends money to another.	Normally specialist funds, who may also consider whole loansWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More

 

What else do I need to know?

Some lendersA company or person that lends money to another. might request a personal guaranteeLenders quite often ask for Personal Guarantees on Loans. Residential Mortgages and BTL Mortgages are automatically guaranteed if you borrow in your own name. If you buy a BTL in a SPV, then normally you would be asked to provide a full PG. For Development Finance and Commercial Mortgages, which are ordinarily held in companies, a lender may ask for a PG to cover some of the loan. With Development Finance, it is typical for a lender to ask for 15%-20% of the Build Costs. On a Commercial Mortgage it is common for a Lender to ask for a PG on the amount of the Loan that exceeds 50% of the property value; so a 65% LTV Loan would attract a 15% PG. before signing off on a commercial mortgageThis term is usually used to refer to mortgages secured against Commercial Investment Properties. Commercial Mortgages need to be supported by the income earned by the asset. The lender will deduct the operational expenses from the Gross Income to calculate the Net Income of the asset. It is the Net Income which the lender will then stress test against internal covenants (Stress Rate, Amortisation Profile) to determine what level of loan they can support. For example: Gross Income = £ 100k, Lender Gross to Net = 85% (£ 85k), Stress Rate = 6.5%, Rental Covenant = 125%, Amortisation Profile = 15 years, therefore Possible mortgage = £ 650,513., although non-banks are less likely to.  This is your legal promise to repay loansWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More issued to your business, so if the business becomes unable to repay a debt, you must accept personal liability.  Essentially, you can’t just jump ship.  The Industry average for a personal guaranteeLenders quite often ask for Personal Guarantees on Loans. Residential Mortgages and BTL Mortgages are automatically guaranteed if you borrow in your own name. If you buy a BTL in a SPV, then normally you would be asked to provide a full PG. For Development Finance and Commercial Mortgages, which are ordinarily held in companies, a lender may ask for a PG to cover some of the loan. With Development Finance, it is typical for a lender to ask for 15%-20% of the Build Costs. On a Commercial Mortgage it is common for a Lender to ask for a PG on the amount of the Loan that exceeds 50% of the property value; so a 65% LTV Loan would attract a 15% PG. is 15%-25% of total loanWhen something is borrowed by one person / entity from another. Normally it refers to money, and a rate of Interest is charged whilst the debt remains outstanding. More amount, but if you’d prefer to deal with lendersA company or person that lends money to another. who don’t request one, a mortgageAn agreement that allows a Borrower to borrow money from a Lender, by using a property as security for the Loan granted. The Lender will take a charge over the property to secure their Loan. expert will be able to advise you regarding the ones to watch.

To see how our clients have benefited from shopping around for the right commercial mortgageThis term is usually used to refer to mortgages secured against Commercial Investment Properties. Commercial Mortgages need to be supported by the income earned by the asset. The lender will deduct the operational expenses from the Gross Income to calculate the Net Income of the asset. It is the Net Income which the lender will then stress test against internal covenants (Stress Rate, Amortisation Profile) to determine what level of loan they can support. For example: Gross Income = £ 100k, Lender Gross to Net = 85% (£ 85k), Stress Rate = 6.5%, Rental Covenant = 125%, Amortisation Profile = 15 years, therefore Possible mortgage = £ 650,513., you can read our case studies here and here.

 

For more advice on securing Commercial Finance, please give one of our experts a call on 0207 846 0184 or email info@propertyfinancegroup.com

 

 

 

 

November 2019