Unlike residential loans that are typically offered to individuals; commercial real estate loans are often given to business entities (for example corporations, trusts, developers and more). And in most cases, getting a loan sanctioned for business property is far more difficult than getting a residential loan. Although there is no difference in the financial documents required by the lending agencies to ascertain the loan eligibility of the borrower, but there are a number of differences in the loan for commercial property and residential loan.
Lets take a look at how commercial real estate loans differ from residential loans
- Lesser Loan-to-Value (LTV) Ratio:
For residential funding the LTV ratio usually ranges between 75% and 90%, however for commercial properties, the LTV can be as low as 55%. This ensures more self-contribution by the borrower in the case of loan for commercial property.
- Higher fee:
The processing fee in the case of residential purchases (by an individual) is a fixed amount of Rs. 10000; whereas for commercial purchases, fees can be as high as 1% of the total loan amount.
- Higher Rate of Interest (ROI):
One can expect a much higher interest rate on commercial properties as compared to residential ones (at least 1-2% higher).
- Loan tenure:
The loan tenure offered in the case of residential properties can be upto 30 years, but for commercial properties, it is typically restricted to 5 to 10 years. One thing to keep in mind is that higher monthly instalments always mean lower total interest cost.
- Debt-Service Coverage Ratio:
When lending a loan to purchase a commercial property, the lenders always consider debt-service coverage ratio (DSCR). DSCR compares a propertys net operating income (NOI) and annual mortgage debt service to get a measure of the propertys actual capability to service its debt. A DSCR value of less than 1 indicates a negative flow of cash. Normally commercial lenders look for a DSCR of 1.25 or more to ensure an adequate cashflow.
- Builder category:
Usually the loan lenders are very particular about the builder’s profile especially if the property is still under-construction. Concern about whether the construction will complete on time is of paramount importance. For this, they do study the previous projects for timely delivery.
It is generally observed that a commercial property takes much lesser time to be constructed as the number of occupants per building is quiet lower than residential projects.
- Minimum Area:
Lending agencies usually prefer funding a minimum area. Except for small spaces called vanilla (normally used for bank ATMs), lenders do not prefer funding spaces lesser than 250 sq. ft. As there are no fixed criteria regarding the minimum area, the decision lies with the lending agency.
While evaluating commercial real estate loans, the lending agencies carry-out an extensive study about the loans collateral (credit-worthiness of the entity), including income tax returns, financial statements (3-5 years) and more.
Finally, we can conclude that although acquiring a commercial property can be a tad expensive with higher monthly instalments, shorter tenure and higher rate of interest; the return in such an investment is the reason to go for it. So, if your property qualifies for a commercial loan, then do not hesitate to go for it.