A landlord may find a shop with a flat above it, an office building that could produce rental income or a mixed-use property offering both residential and commercial opportunities.
These properties can be attractive investments, but they do not normally fit standard residential or buy-to-let mortgage criteria.
Commercial and semi-commercial finance involves different lenders, valuations, affordability assessments and legal considerations. The finance conversation should therefore begin before the purchaser makes an offer.
What is a commercial property?
Commercial property is intended principally for business use.
Examples include:
- Shops.
- Offices.
- Warehouses.
- Workshops.
- Industrial units.
- Restaurants and cafés.
- Hotels and guest houses.
- Healthcare premises.
- Land used for commercial purposes.
The property may be purchased for the borrower’s own business or as an investment that will be rented to another organisation.
This distinction is important. A lender assessing an owner-occupied business property will examine the trading business’s ability to make the mortgage payments. For an investment property, the lender will concentrate more heavily on the lease, tenant, rent and property’s investment value.
What is semi-commercial property?
A semi-commercial or mixed-use property contains both residential and commercial accommodation.
The most familiar example is a shop with one or more flats above it. Other possibilities include an office with residential accommodation, a public house with an owner’s flat or a building divided between commercial and residential tenants.
The lender may consider:
- How much of the building is residential.
- The type of commercial use.
- Whether the different parts have separate entrances.
- The lease arrangements.
- Whether the residential and commercial areas can be sold separately.
- Planning and lawful use.
- The strength of demand for the complete property.
- How easily it could be sold if the mortgage was not maintained.
Two apparently similar mixed-use properties may therefore produce very different lending decisions.
Why will an ordinary buy-to-let mortgage not work?
A standard buy-to-let mortgage is generally intended for a property used entirely as residential accommodation.
Once part of the building is used for business purposes, the lender must assess risks that are not present in an ordinary house or flat.
A commercial tenant may occupy under a longer and more complex lease. The premises may have been adapted for a specialised use, and the number of potential future occupiers could be limited.
A flat above certain types of commercial premises may also be unacceptable to some residential lenders, even when the flat has its own title and entrance. Noise, smells, opening hours, access and future saleability can all influence the decision.
The complete property and its occupation must be described accurately from the beginning.
How will the lender value the property?
Commercial valuations are more specialised than standard residential valuations.
A residential valuer may rely heavily on recent sales of comparable houses or flats. A commercial valuer may also consider:
- The current and potential rent.
- The length and terms of the lease.
- Rent-review provisions.
- The tenant’s financial strength.
- Local demand for the type of premises.
- Property condition.
- Alternative uses.
- Comparable investment sales.
- Expected yield.
- Costs that cannot be recovered from tenants.
- How easily the property could be sold.
For a mixed-use building, the residential and commercial elements may be examined separately before an overall value is reached.
The amount a purchaser has agreed to pay does not determine the lender’s valuation. If the valuation is lower than expected, the buyer may need to provide a larger deposit or renegotiate the purchase price.
The tenant and lease can affect the mortgage
Where a commercial property is already rented, the lender will want to understand the tenancy.
A long lease to an established tenant may be viewed differently from a short agreement with a new business. However, a longer lease is not automatically stronger if the rent is unsustainable or the tenant’s financial position is uncertain.
The lender may examine:
- The tenant’s trading history.
- Current rent and payment record.
- Remaining lease term.
- Break clauses.
- Repairing obligations.
- Rent-free periods or concessions.
- Restrictions on assignment or subletting.
- Upcoming rent reviews.
- Responsibility for insurance and service charges.
A vacant property requires a different assessment. The lender may ask how long it is expected to remain empty, how a new tenant will be found and whether the borrower can meet the mortgage and running costs during that period.
How is affordability assessed?
For an owner-occupied commercial property, the lender may review the business’s accounts, profitability, cash flow and ability to service the proposed debt.
For a commercial investment, the rent will usually be central to the calculation. The lender may apply a rental coverage requirement and test the borrowing at an interest rate above the initial product rate.
The borrower’s wider financial position can also matter.
A lender may request:
- Business accounts.
- Tax calculations.
- Bank statements.
- Details of other borrowing.
- A schedule of existing properties.
- Copies of commercial and residential leases.
- Evidence of deposit funds.
- A business plan.
- Details of the purchaser’s relevant experience.
- Information about proposed refurbishment or conversion work.
A strong property does not compensate automatically for weak finances, just as a financially strong borrower cannot make every property acceptable.
Expect different deposits, rates and fees
Commercial and semi-commercial mortgages can require larger deposits than standard residential or buy-to-let borrowing.
The available loan-to-value may depend on the property, commercial use, lease, tenant and applicant. Specialist or unusual premises may attract more cautious lending.
Borrowers should also budget for:
- Arrangement fees.
- Specialist valuation fees.
- Legal costs.
- Broker fees where applicable.
- Survey costs.
- Insurance.
- Property transaction tax.
- Environmental or structural reports.
- Possible lender monitoring costs.
Legal and valuation work can be more involved, particularly when the property has several leases, separate titles or complex commercial use.
The headline interest rate should therefore never be considered in isolation.
Refurbishment and conversion create further questions
Some mixed-use properties are purchased with plans to refurbish, convert or alter their use.
A long-term commercial mortgage may not be available while major work is required. Bridging, refurbishment or development finance might be needed initially, followed by refinancing when the project is complete.
Before relying on that strategy, the purchaser should establish:
- Whether the proposed work requires planning permission.
- What building-regulation approvals are needed.
- Whether existing leases restrict alterations.
- The realistic refurbishment budget.
- How interest and costs will be funded.
- The likely completed value and rent.
- Which lender might provide the eventual long-term mortgage.
- What happens if the project or refinance is delayed.
The exit strategy should be investigated before the short-term finance is arranged.
Prepare before making an offer
Commercial and semi-commercial property finance is highly dependent on the exact property, borrower and intended use.
A shop with a flat above it cannot be assessed properly from the purchase price and combined rent alone. The lender needs to understand the building, leases, tenants, business use, valuation and borrower’s financial position.
NetRent Mortgage Solutions works with DNA Financial Solutions to help landlords and property investors investigate commercial, semi-commercial, bridging and development-finance options.
To discuss a proposed purchase or refinance, contact NetRent before committing:
Telephone: 01352 721300
Email: mortgages@netrent.co.uk
NetRent does not provide legal or tax advice. This article represents our general understanding of the mortgage and property market and is provided for information only.
Commercial mortgage products, rates, fees, valuation methods and lender criteria can change. Appropriate mortgage, financial, legal, valuation and tax advice should be obtained before proceeding.