Commercial Property Financing Can Have Its Challenges
Depending on the situation, proper
commercial property financing can be one of the most
challenging sources of capital to locate and secure for
your business.
Unlike residential real estate, the
process of locating suitable commercial property lenders
can be far more complex. There are a number of reasons
for this disparity.
First, the resale market for commercial property is much
smaller than residential property because it’s more of a
business to business sale versus a consumer based sale
which typically generates a much large volume of
transactions throughout the year. The smaller the
potential market, the less predictable the resale
ability of the property.
Second, it can be difficult to accurately assess value.
Commercial properties are usually appraised by both an
income approach to value and comparative sales in an
attempt to establish a more accurate value estimate. But
even with this two pronged approach, there are
complicating factors.
Depending on location, there may not be any strong
comparable sales. And an income approach to value by
itself, can speak more to the management of the business
than the value of the physical location.
Yet, despite these complicating factors, commercial
property financing is the financing jewel for all
institutional lenders like banks, credit unions, and
trust companies.
Why?
Because larger scale commercial buildings in strong
business areas command solid rental income from well
established and financially stable companies. Because of
the marketability of the rental space, and the financial
strength of the tenants, the commercial property
financing options are both larger in numbers and highly
competitive in terms of lending rates.
Even if a company owns a large commercial property
strictly for its own purposes, the resale value and
income potential remains high because of location and
use.
Couple all this with large investment values and you can
see why banks trip over each other for these types of
properties.
Even for smaller scale properties that fall within the
category of excellent location and strong tenant base,
the commercial property financing options are very
strong.
But once you get outside of this model, where the risk
of return becomes less certain, the commercial property
financing market is much more difficult to navigate.
Commercial properties that have fewer tenants, or are
owned and operated, and are not in highly marketable
areas, have a higher risk of failure from an
institutional lender’s point of view. Add to this the
diverse usage of smaller properties, you can see why if
a lender had a choice, they would put their money in
lower risk commercial holdings.
So for many small and medium sized businesses,
commercial property financing can become quite a
challenge. Even if you locate an interested lender, the
percentage of the loan to the value of the property will
likely be 65% or lower, and the interest rate will be
higher than for other commercial lending scenarios.
The good news is that because there is so much
investment value in commercial property, there are
numerous lenders that service these markets.
And like other types of business financing, this larger
number of smaller lenders manage their risk by being
more niche focused.
Commercial property financing for small and medium sized
businesses can be impacted by geography, industry,
sector, current property use, historical property use,
and future potential property use.
Here’s an example. Say that you want to buy a gas
station in a small town. The geography will be a factor
as to the understanding of the local market. The use
will be a factor because of the potential environmental
impact and related liability associated with underground
gas and fuel tanks. The industry will be a factor in
terms of the established profitability of the location
in question, your management ability related to
operating a gas station, and the affiliations and/or
contracts you have with your supplier.
Of course there are lenders that provide money for this
type of purchase, but they will be specialized in
this type of commercial property financing application.
And like other forms of business financing, all the
relevant lenders may not be easy to locate, potentially
resulting in you either not finding financing at all and
your deal falling through, or you secure more expensive
financing than what is available to you, reducing your
profitability.
If you are an existing business that owns commercial
property, it can be hard to leverage the equity you have
in the property if you need if for operating purposes.
Many times businesses go through a down turn in their
business cycle and turn to their bank to get some bridge
financing to see them through only to find out that all
the equity they have built in their commercial real
estate is of little interest to their banker.
Again, the property value is closely associated with the
cash flow it generates. If a business fails and the bank
has to repossess the commercial property, it can take
several years for the bank to liquidate its position in
the asset in an attempt to get its money back and/or
mitigate its losses.
Another lending trap with commercial property financing
is when you are in the process of buying a business, the
lender provides a financing package based on the value
of the property, but places a blanket security agreement
on all other assets, restricting your ability to operate
and raise working capital if necessary.
Regardless of the scenario, commercial property
financing can be quite challenging with respect to
sourcing, lending ratios, rates, terms, and operating
covenants.
Just remember that there usually are relevant options. The
trick is to find what best fits your situation.
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