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Commercial Finance (Part 1)
What types of commercial finance options are available for businesses in the UK?
There’s a multitude of different commercial finance options for clients, depending on what they’re looking for.
Some commercial finance is predominantly for acquisition of property. It could be property that a client currently operates their own business from, or an investment property to let to a business as their premises.
Another type of commercial finance is asset finance, used to procure an asset for a business. Maybe you’re a construction company and you need to buy a digger – that digger would be an asset. Maybe you’re a distribution company and you have a fleet of 12 vans which need to be replaced. They’re all assets, so you would look at asset finance.
Another area is invoice financing, where a finance provider will pay a proportion of all your invoices on day one. Rather than waiting 30 or 60 days to get paid, you could have an element of that money paid upfront to help your cash flow.
You can also get unsecured or secured lending. Perhaps a company needs £50,000 to refit a shop – they could get a loan secured on the property, or even unsecured. You could often get an unsecured business loan up to about £150,000, subject to various caveats and qualifications.
There are lots of different types of commercial finance – it could also be something as simple as setting up business banking facilities. Predominantly that would be for a business that’s just going to start trading.
Today, we’re probably going to discuss commercial property finance, because the vast majority of the enquiries we receive are property related. People often want to buy property as an investment or to operate a business from.
How does commercial finance differ from residential mortgage lending?
With residential mortgage lending, you apply for a mortgage and you’re going to live in that property. With commercial finance, there’s going to be some sort of commercial operation from the property.
It could be anything: a grocery shop, a restaurant, anything in the retail sector, or a firm of solicitors who want to buy an office. There is simply some sort of commercial activity within that property – and you could have several different businesses in one building.
You could, for example, buy a building on one freehold with several floors. You could have a firm of accountants on one floor, an estate agent on the ground floor and various different companies operating from that property.
Commercial finance could also help somebody buy premises from which to operate their own business. Perhaps you’re a firm of solicitors, accountants or financial advisors, and you want to buy an office. It’s not really for investment purposes, because your business is going to be running from that building.
Lenders approach these two things differently – lending for investment versus for commercial operation.
What are the current interest rates for commercial finance in the UK?
Another big difference with residential as opposed to commercial, is that when you apply for a residential mortgage, the rates are set. There’s no discretion from a lender to be more flexible on rate if you’re a better risk than somebody else.
If a residential rate is 5% fixed for five years, that’s what everybody gets – as long as the Loan to Value and other parameters stack up. It’s different with commercial financing. A lender will look at a proposition, assess the strength of the security – the property, its location and desirability.
They will also look at the viability of the business that’s going to operate from that commercial premises. They’ll look at the strength of the lease – these vary widely. It could be a 10 year lease with a five-year break clause. Some leases on buildings could be in excess of 20 or 30 years.
That’s great if you own that property, particularly if you’ve got a blue chip client, as it means you’ve got that money coming in for the next 10, 15, 20 years – however long the lease is.
This is where a broker comes into the equation. We would look at the proposition and take it to a lender. They would then give us ‘indicative terms’, explaining that they’re happy to lend and the rates they could offer based on the loan amount, the Loan to Value, the strength of the property, the underlying business and the financials involved.
What criteria do businesses need to meet in order to qualify for commercial finance?
As with residential mortgages, there are lots of lenders. If you want to apply for a residential mortgage and you’ve had credit blips in the past, there’ll be a lender that will look at doing it.
It’s similar with commercial finance. For example, if you’re looking at high Loan to Values or you’ve never owned a commercial investment before, there are lenders out there that will lend.
The better the proposition and the more criteria boxes you tick, the more lenders we could go to, and the better rate you’re going to get.
What documentation is typically required?
The documents vary depending on the lenders. If you’re going to buy commercial investment property, they’ll probably want to see the lease. They will do a credit check on the directors of the company buying the property, or the individuals buying the property.
It’s more relaxed, because there are no real affordability checks as with residential mortgages. We just make sure that the rental calculation for the property matches affordability criteria for the lender and their interest rate that they’re going to charge.
That will largely be down to a survey on the property. A specialist commercial surveyor will go out and give an indication of the likely rental income. That will be used to calculate how much you could borrow against a property – and therefore the deposit you need to put in.
Standard documents are proof of ID and proof of address for money laundering regulations. But it does vary depending on the application and the sort of property you’re looking to buy. It tends to be less cumbersome than residential, which is obviously very highly regulated and based on strict affordability criteria. Commercial is more relaxed – and there are different options that you don’t get with residential.
How do lenders evaluate the creditworthiness of businesses seeking commercial finance?
The business isn’t the most important part of this process. If you set a company up today to invest in commercial property, you won’t have any trading history.
In that scenario, a lender would just look at the directors of that business and any shareholders with a large stake in that business, and run credit checks against them. Providing that’s fine, that’s good to go.
If the business has been trading for several years and has accounts, a lender will still do checks on the directors – because ultimately the directors control that business. They’ll also check the accounts have been filed at Companies House and there are no red flags.
With regards to credit checks, there are lenders out there who are happy to look at a commercial application where one or more directors have had credit problems in the past. Again, you will pay a slightly higher interest rate, but that’s expected where there are credit blips.
What are the benefits of using an advisor for commercial finance compared to going direct to a lender?
The most important thing about using a broker is their knowledge and experience. It’s very difficult to walk into a high street branch of Santander or Barclays and speak to somebody about commercial finance. There aren’t usually any experts in that field at the main banks.
A broker will use their experience to go to a specific lender in that particular area. To compare it again with residential, if you go to Halifax, they will lend in any town or city in the UK. But if you want to invest in a farm, there are numerous lenders in the UK specialising in that area. They will have a deep knowledge of the agricultural sector.
A good broker will know which lenders to go to with a proposition for the right rates. It may be possible to get a deal with a lender who doesn’t specialise again in lending on farms or agriculture, but you’re probably not going to get the lowest rates.
There are lenders for a whole host of different industries. Some lenders specialise in lending to nurseries, care homes, the retail sector or the hospitality sector. If you want to buy a pub, a bar or a restaurant, a good broker will take you to a lender that specialises in the hospitality sector.
It’s also about putting a good proposition together for those lenders. If they understand the proposition they’re much more likely to offer you very competitive indicative terms. That’s what a broker does.
Can you explain the process of obtaining commercial finance from start to finish?
The first stage is for a broker to get as much information as possible about what you’re looking to do. They’ll ask what you want to achieve from taking out commercial finance. If you already have commercial finance, is it to get better terms? What’s the long-term plan, the medium-term plan, and what are you looking to achieve?
That will involve going into detail about your existing arrangements. We then take that proposition to a lender. At this point, it’s just a very generic conversation. If the lender is interested in this proposition, we will put together a more formal application.
That would involve ID and fraud checks and a specific application for the lender, with the property address, details of the income from the property and the directors of the business.
The lender will approve the application, issue some terms and if the client’s happy, the next stage is usually to get the property valuation done.
Commercial valuations are different from residential valuations. They’re more in-depth. They’ll go into a lot more detail about the area, the demand for that business and the potential tenants, as well as the property value.
If everything stacks up, the solicitors will get involved. They work for whoever is taking out the commercial finance, plus there’s another solicitor for the lender. They will satisfy any conditions that the lender requires, and then it’s a case of drawing down the funds and completing the purchase or refinance.
Depending on the complexity of the deal, you could be looking at anything from two to four or five months for a deal to go through.
What are some common challenges and obstacles businesses face when trying to secure commercial finance?
The biggest obstacle for most people, particularly if they haven’t taken commercial finance out before, is the deposit. People often think they could put a small deposit in, similar to a residential mortgage, to borrow 90-95% of the property value.
That’s not going to happen with commercial. You’re probably going to need a 25% deposit as an absolute minimum – but there are some exceptions. If you are looking to buy a doctor’s practice or a dental practice, you could potentially get 100% funding.
It’s always worth speaking to a broker about what you’re proposing to do and the deposit you need to put down. In some cases, depending on the strength of the proposition, a lender may be happy to lend, but only to a maximum of 60%. You would then need to get a 40% deposit together.
Other potential stumbling blocks are where you’re looking to buy a retail unit that’s not had a tenant for two or three years. A lender would want to know why you want to buy that. Are you going to operate your business from there? Are you going to try and lease the property? Is there a reason that property hasn’t had a tenant in the last few years?
The better the proposition, and the better the story we could submit to the lender, the more likely they are to accept it.
Are there any specific regulations or legal considerations that businesses should be aware of when applying for commercial finance?
One of the first things to check is that the commercial premises has the appropriate class for the business you intend to operate there. Every property is assigned a business class that determines what could operate from those premises.
If you want to buy a convenience store, but turn it into a takeaway restaurant, that would involve a change of class. A takeaway will involve food preparation, and have to meet food standards. It may be open late at night. If it’s directly underneath residential property, it’s probably not going to get the appropriate class.
So, check if a property has the appropriate class. If not, you’re going to have to apply for planning permission to change that. It could sometimes be quite difficult to change the class on a building – particularly if that building has had the same class for 20 or 30 years. Changing that could sometimes lead to objections from people who live locally.
You will have a solicitor involved in the process, and they will guide you on any legal aspects. But, you should make sure the property has the appropriate fire safety standards.
That will usually be part of the conditions in a lender’s offer. A fire safety check will need to be carried out on the building, confirming there are appropriate exits etc.
What are the typical repayment terms and options for commercial finance in the UK?
They are pretty flexible. You could do interest only, where you’re just paying the interest on the loan; or capital and interest where you’re paying back the commercial finance debt each month.
It depends on the lender and the asset. Quite a few lenders will allow interest only, particularly if it’s investment property. If you’re going to buy premises to operate your own business from, a lender will probably insist on you having capital and interest terms rather than just interest only.
Usually you could go up to 25 years, which is similar to residential. You could get all sorts of different products. There’ll be trackers, discounts, variables and fixed rates. You could fix for five years, 10 years, or even for the whole period of the finance – potentially up to 25 years.
You could have different terms, as well – if you want to borrow £500,000 with £300,000 on capital and interest, and the other £200,000 on interest only, lenders will consider that.
If this is a new business and you’ve yet to get up and running for the cash flow to come in, some lenders are happy to defer all payments for the first six months. There are various different things that could help with the payment terms and make it appealing both to yourself and the lender.
How long does it usually take to get approved for commercial finance?
It’s quick. If somebody came to me this morning with a proposition, I could take that to the lenders I think would be interested this afternoon. By lunchtime tomorrow I’d have a definitive answer from those lenders, with the terms they would be prepared to lend on. I could certainly get you a response within 24 hours of an enquiry.
COMMERCIAL LENDING AND SOME BRIDGING FINANCE IS NOT REGULATED BY THE FINANCIAL CONDUCT AUTHORITY.
COMMERCIAL LENDING IS NOT PART OF THE OPENWORK PARTNERSHIP’S OFFERING, THIS IS OFFERED UNDER THE FIDUCIA NETWORK LTD. THE OPENWORK PARTNERSHIP ACCEPTS NO RESPONSIBILITY FOR THIS ASPECT OF OUR BUSINESS.
Approved by The Openwork Partnership on 10/10/2024.
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Commercial Finance (Part 2)
What factors determine how much businesses can borrow through commercial finance?
The strength of the proposition is always the key to how much you could borrow and the indicative rates that a lender will offer.
The better the proposition and the more experienced you are, the better. For instance, we worked with a client on an office conversion in West London, where we looked at 75% of the site’s procurement value., which was several million pounds, and we looked at a separate loan for 100% of the development cost to convert the offices into residential units. The developer was very experienced. They knew that particular area of West London and had done several similar projects.
It’s easy in those circumstances to ensure a lender will be comfortable with the deal. It becomes more challenging if, for example, you don’t have experience, or you want to put as little deposit down as possible.
You might be looking to get involved in development finance, not necessarily on a big project, where you’ve got a plot of land and want to put a couple of houses on it. There are lenders that will do that. But if you haven’t had any development experience at all, some lenders would decline it.
Other lenders would be prepared to lend, but they may want you to put a bigger deposit down to mitigate some of that risk. So it all depends on the proposition and what the lender is looking to lend in that particular area.
Do businesses need to have a certain track record or years in operation to be eligible for commercial finance?
The short answer is no. You could set a business up today with some element of commercial finance. A lender would look at the directors and any big shareholders, and if they have a clean credit history they may be happy to lend.
It depends obviously on what you’re borrowing for, but you don’t need any minimum trading period. If you are trading as a business and you have got accounts, that helps enhance the proposition.
But you may be, for example, buying a commercial unit as an investment and you don’t necessarily know who is going to occupy those premises. In that scenario, it’s down to the surveyor. They might say that with a 10-year lease, those offices may generate £50,000 a year in rental income – it depends obviously on the location and size. That figure would be used by the lender to decide what to lend.
Can you explain the concept of loan to value ratio or LTV in commercial finance?
It’s the same as in residential. Loan to Value is how much you’re borrowing relative to the value of the property. So if the property is worth £500,000 and you’re looking to borrow £250,000, that’s 50% of the property value and 50% Loan to Value.
In that scenario, the lender would give you a mortgage for £250,000 and you would need to make up the difference with a deposit of £250,000.
The bigger the loan you’re looking for, the higher the interest rate will be. So if you only had £150,000 to put down instead of £250,000, the same lenders will probably be prepared to lend, but you may pay a higher rate of interest.
From the lender’s point of view, lending on a higher loan to value means they potentially have less security should they need to repossess that property.
What are the potential risks or downsides of using commercial finance for businesses?
It depends on what the finance is for. If you’re borrowing for property investment, obviously you have an underlying security and it should be a pretty good investment over the years.
Commercial property investment, done right, could be very lucrative. You could get better returns than on a standard Buy to Let, and the premises will go up in value – depending on where it is and various other factors. If you’re in a city centre, obviously you’re probably going to get more footfall than if you are located somewhere out of town.
The risks involved are around buying the wrong premises, not looking after or maintaining the premises, or getting a tenant who can’t pay the rent.
When you’re buying a property, you should also make sure it’s got all the fire certificates and health and safety requirements required, if the public may be accessing the building.
The risks are similar to residential property investment, but on a much bigger scale. It clearly depends on what sort of commercial operation will be working from the property. It could be a good investment – but there are always risks with any investment, whether that’s in commercial property, residential property or anything else.
Are there any restrictions or limitations on how businesses can use funds obtained through commercial finance?
No. As long as you’re using those funds for a legal purpose, you could borrow for pretty much anything.
It doesn’t necessarily have to be spent on the business. If you have a property with equity in it and you’ve got a large tax bill to pay, some lenders will be happy to lend against the property for you to pay that bill.
You could be raising money to refurbish the property. As long as it’s for legal purposes, commercial lenders don’t ask too many questions. They obviously need to do their plausibility checks and make sure it stacks up and makes financial sense, but most propositions will be considered.
How can businesses ensure they choose the most suitable commercial finance option for their specific needs?
Go to a broker that knows the market. We will take you and your proposition to a lender that specialises in that industry, whether it’s hospitality, care homes, hotels or something else.
A broker deals with the lenders and will know the particular market segments in commercial finance where lenders specialise. As a result, we could get you the right rates and terms for your proposition.
What ongoing support or services do brokers provide to businesses after securing commercial finance?
Ultimately it depends on the terms and the type of commercial finance. For example, if somebody wants to buy a rundown shop, we may look at a commercial bridging loan for that property. The term might be 12 months. The client will go in, refurbish the property and bring it up to a better specification to make it more appealing to tenants.
At the end of that, our service to the client will be around how they will pay this bridging loan back. They’ve refurbished the premises to get a better rent, and enhanced its value. We’d now look at getting commercial term finance to pay the bridging loan back. That will be at better rates than a commercial bridging loan.
We also take a more long-term approach. If we set up commercial finance today for somebody on a five-year, fixed rate term, then we will be contacting that client in four and a half years’ time to discuss their options and what’s available in the marketplace.
I’ve always helped clients with non-finance related queries at any time. I’ve had clients come back because a tenant in their commercial property hasn’t paid the rent. They’ve asked me to recommend a good solicitor to help with the legals. I’m always getting asked for good accountants, surveyors and lawyers.
We help people navigate commercial finance and everything involved with it. I’ve been doing this for 25 years, and I’ve accumulated a lot of knowledge to help clients achieve their goals.
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What are the typical fees and costs associated with commercial finance?
Ultimately the starting point would be the type of deal and how complex it is. You’re going to have to pay legal fees and property survey fees, which depend on the complexity of the deal.
If, for example, you’re buying an office with several different tenants all working in different businesses, a solicitor will check the lease agreements for all those tenants.
There’s quite a bit of work involved there, so you would expect to pay more on the legal front. With a surveyor, a standard property valuation is fairly straightforward. But on that development in West London, where that client was converting offices into flats and affordable housing, it was more complex.
There was an initial appraisal of the property, and then the surveyor was involved throughout the development. They went back regularly to check it was on track, and updated the commercial lender on whether the project was meeting targets and necessary standards. Obviously, the costs are going to be bigger for a large development.
If you ask me what the fees are, I would allow 1.5% of the funding cost for legals, and a similar amount for survey costs. Lenders, depending on the type of finance, will probably charge perhaps 2% of the loan amount as an arrangement fee.
You would also have to pay the broker for going to the lender with your proposition. Expect to pay anything from 0.5% to 1.5% of the loan amount as a broker fee.
Because we have experience of many different commercial deals, we confirm to each client the likely costs they will incur. We could give you a good idea of the costs involved before you take an application any further.
Are there any tax implications or considerations businesses should be aware of when using commercial finance?
I would suggest speaking to an accountant because I’m not a tax specialist. You should always seek proper specialist tax advice.
There are some benefits to commercial property investment as opposed to residential property investment in terms of stamp duty. That’s particularly true if you’re buying a rundown property that you intend to refurbish. You could get some tax benefits from that.
The cost of refurbishment could be offset as a capital expense – but again that needs to be corroborated by your accountant. There are probably more tax breaks for commercial property than for residential property. There is still usually stamp duty, but again, in some circumstances you could mitigate some or all of that.
You could have capital allowances if you spend money refurbishing a property, so speak to your accountant or a tax specialist and find out exactly what’s involved before you jump in.
What advice or tips do you have for businesses seeking commercial finance in the current economic climate?
As long as I’ve been doing this job, which is now 25 years, I don’t think we’ve ever had a benign economic climate. There’s always been something going on.
Interest rates right now in August 2024 are still fairly low. When I came into this job, the Bank of England interest rates were 8%, 9% and 10%. So one tip is to take a longer term fixed rate if you are getting involved in commercial finance for the first time. It gives you the security of knowing exactly what you need to pay to fund that finance for a given period.
A long term fixed rate protects you against interest rates spiking up. Nobody foresaw the pandemic, and that led to lots of economic stimulus.
Governments all over the world pulled money into the economy. Then, when we came out of the pandemic, inflation and interest rates shot up. We’re now seeing those interest rates come down. But people on variable rates had a big shock. Some saw the interest rates they were paying double or more.
We don’t know what’s round the corner. We have a war in Ukraine at the time of speaking. We’ve just gone through the pandemic and nobody saw those events coming.
If you’re experienced, there are various different things you could do with commercial finance on a variable rate. But if you’re fairly new to it, a fixed rate could protect you against unforeseen economic events. Without sounding bleak – and I’m not inherently a pessimist – it’s a good idea to always expect the worst. If it never happens, you’ve always got a smile on your face.
What future trends or developments do you anticipate in the commercial finance industry in the UK?
If you were to ask me this question in three or five years’ time, I’d probably give you a completely different answer. But as with everything in the world, commercial lenders are always innovating. They’re always looking at how they could do things better and how to integrate new technology.
If you said to me 10 years ago that you could sign a document electronically anywhere in the world, I probably would have laughed. But lenders do that now. They’re happy to accept deeds and legal documents signed while you’re on holiday in Australia.
How do I think commercial finance will change? I think it will adapt to the circumstances.
There are more lenders now, and 10 years ago – maybe even five years ago – most commercial finance was done on variable rates. You paid maybe 1.5% over the Bank of England base rate.
But lots of people want fixed rates now because of what’s happened, as per my previous answer, with the pandemic and interest rates shooting up. Lenders are adapting to that, even ones who never previously offered fixed rates are coming into the market.
That’s something we’ve had in residential mortgages for years. And often what happens in residential filters down to commercial finance. The signing of electronic documents, online identity and fraud checks, online address checks – they are all happening now in commercial lending.
There will be more changes going forward. I’d love to be able to tell you what they will be. Everything’s changing and there are new developments we couldn’t predict.
I’ll give you an example. A friend of mine recently arranged finance for a private jet. The client was a very wealthy individual based in Dubai. If someone had suggested to me 15 years ago that we could arrange lending for private jets, I would think they were joking. But so many people use private jets now that it’s becoming an industry in itself. There are several lenders in that marketplace, and that’s all they do.
So there’s constant innovation. If you’re not sure, ask a broker. Explain what you’re looking to do and ask if we know anyone that will lend against it. The answer to the question could well be yes [podcast recorded in August 2024].
HM REVENUE AND CUSTOMS PRACTISE AND THE LAW RELATING TO TAXATION ARE COMPLEX AND SUBJECT TO INDIVIDUAL CIRCUMSTANCES AND CHANGES WHICH CANNOT BE FORESEEN.
COMMERCIAL LENDING IS NOT PART OF THE OPENWORK PARTNERSHIP’S OFFERING, THIS IS OFFERED UNDER THE FIDUCIA NETWORK LTD. THE OPENWORK PARTNERSHIP ACCEPTS
NO RESPONSIBILITY FOR THIS ASPECT OF OUR BUSINESS.
COMMERCIAL LENDING AND SOME BRIDGING FINANCE IS NOT REGULATED BY THE FINANCIAL CONDUCT AUTHORITY.
YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.
SOME BUY TO LET MORTGAGES ARE NOT REGULATED BY THE FINANCIAL CONDUCT AUTHORITY.
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