Commercial Property finance

[Peter1952]

As a small business owner I find it ridiculous that if I want to buy business premises I have to pay a 25 to 30% deposit and then pay the bond off over 10 years. This makes it well nigh impossible for a small business owner to own his own property.

Why is it possible to buy residential property and pay it over 20 years or more but not commercial property?

Is there another route one can use?

[ArcSine]

The differences can be attributed to the risk perceptions in the eyes of the originators / banks. For example, conventional wisdom has it that if a business owner gets into financial difficulties, he'll redirect all his efforts and remaining resources toward saving his residence, and allow his commercial property to be sacrificed to the repossession gremlins, if it comes to that.

Similarly, a residential mortgage is often supported primarily by the owner's "every Friday" paycheck (and frequently a spouse's, to boot), whereas a commercial loan's first line of support is the net cash flow of a business. The latter is, of course, usually significantly more unpredictable than the former. Businesses go bust on a regular basis, but families tend to be around for the long haul.

Also there's a much more robust secondary market for residential paper. This means a bank will frequently only have its money tied up in a 30-year mortgage for a very short time, whereas for a 15-year commercial note, the bank's at risk the full 15 years (albeit on a declining absolute amount of exposure, of course).

None of which makes your frustration any less annoying, I'm sure. Hopefully someone familiar with funding and financing programs in your particular area will weigh in with some attractive alternatives.

[Blurock]

Good answer ArcSine. Welcome to The Forum SA. How about an introduction?

[ArcSine]

'Preciate that, Blurock. The intro's on the books.

[Blurock]

Thanks for the profile Arcsine. Hope you were spared Sandy's devastation.

[ArcSine]

Yes, thanks, I'm significantly south of where Sandy made landfall. But 'devastation' is indeed an accurate term for those in Sandy's path. Thoughts and prayers to 'em all.

[Peter1952]

The differences can be attributed to the risk perceptions in the eyes of the originators / banks. For example, conventional wisdom has it that if a business owner gets into financial difficulties, he'll redirect all his efforts and remaining resources toward saving his residence, and allow his commercial property to be sacrificed to the repossession gremlins, if it comes to that.

Similarly, a residential mortgage is often supported primarily by the owner's "every Friday" paycheck (and frequently a spouse's, to boot), whereas a commercial loan's first line of support is the net cash flow of a business. The latter is, of course, usually significantly more unpredictable than the former. Businesses go bust on a regular basis, but families tend to be around for the long haul.

Also there's a much more robust secondary market for residential paper. This means a bank will frequently only have its money tied up in a 30-year mortgage for a very short time, whereas for a 15-year commercial note, the bank's at risk the full 15 years (albeit on a declining absolute amount of exposure, of course).

None of which makes your frustration any less annoying, I'm sure. Hopefully someone familiar with funding and financing programs in your particular area will weigh in with some attractive alternatives.

Thank you for the feed-back. You mention a 15 year repayment. I was under the impression that it is 10 years?

[ArcSine]

I just used 15 as an arbitrary example. Sorry for not clarifying that. Actually, commercial notes come in various maturities, as do all types and classes of loans. I've seen 7-year terms, 10s, 15s, and everything in between. The maturity (and other terms) an institution is willing to offer is somewhat idiosyncratic, depending on the bank's own experience and focus, the nature of the underlying collateral, and so on.

I was just pointing out some of the rationale for why commercial paper tends to have shorter maturities than residential paper, on average.

[Peter1952]

I just used 15 as an arbitrary example. Sorry for not clarifying that. Actually, commercial notes come in various maturities, as do all types and classes of loans. I've seen 7-year terms, 10s, 15s, and everything in between. The maturity (and other terms) an institution is willing to offer is somewhat idiosyncratic, depending on the bank's own experience and focus, the nature of the underlying collateral, and so on.

I was just pointing out some of the rationale for why commercial paper tends to have shorter maturities than residential paper, on average.

Oh, I see. Do you think the same terms will apply if I buy the business premises in my own name?

[roryf]

One other thing that should be noted is that the banks will only fund the bond for their valuation of the property.So if you want to buy a commercial property for say R1 million and the bank only sees R800k of value they will want a R240k deposit (if at 30%) and a payment of R200k and will only finance the balance of R560k.

We were looking a while back and this is what I found.I have put saving measures in place for when we finish our current lease.Looking forward to getting my own premises!

Our bank said they would consider the amount and period they financed by looking at what we currently payed in rent and then they would also want 4 years worth of sales forecasts and cashflows.

It is still very difficult to make it happen though.

[ArcSine]

Do you think the same terms will apply if I buy the business premises in my own name?

Hard to say, but probably not materially. Fundamentally, it's still a commercial property deal (supported by both your personal and biz balance sheets, per next para) as far as the lender's concerned.

For one thing, only the balance sheets of large companies with established histories can get senior debt financing without backup support from the principals' personal guarantees (that's the general rule, but of course you can always find exceptions). So whether you acquire the premises (and obtain the financing) in your name or in your entity's name, either way it's likely that both you and your entity will be signed on the note; the only diff is which one of you is the primary obligor, and which is co-signing.

Hence, either way the bank sees it as a financing collateralized by both parties (you and your entity) and the property itself.

As Roryf's anecdote attests, it's a risk-perception issue from where the bank sits, and there's definitely room for negotiation in most deals. For example, the more safety nets you can offer up to mitigate the lender's risk, the likelier they'll respond with more lenient or favorable terms. It's possible they'd stretch the maturity by a few years if, say, you had additional collateral to throw in, or perhaps had a private investor willing to put in some additional equity (so that the bank's LTV comes down a bit). (Standard caveat: Before putting additional personal assets at risk, make sure your biz cash flow forecasts are solid, at least as far as reading the ol' crystal ball can be referred to as 'solid' )

Also, different lenders have different appetites, so talk to more than one. You'll come away from that exercise with a better feel for what kind of terms you'll be offered, as well as ideas on what you might do to improve your bargaining position. If nothing else, bank's lobbies usually have fairly decent complimentary coffee, even if it ain't Starbucks.

[Blurock]

Thank you for the feed-back. You mention a 15 year repayment. I was under the impression that it is 10 years?

Different rules apply in different countries. As ArcSine is in the US, he is commenting on what applies there.

Currently in South Africa the banks will only consider 10 years and they are getting very sticky with property finance due to the high risk of business default (as explained by ArcSine). Banks will not even consider 100% bonds on commercial property unless you can cover the 20% with a fixed deposit or other tangible security. Business Partners will still consider 100% bonds, but with very onerous conditions and at a higher interest rate.

[ArcSine]

I appreciate the point, Blurock; I know lending standards and practices are regional-specific, but I didn't realize the SA banks were clamped down quite to that degree of conservatism with respect to maturities. Thanks again for the heads-up.

[Blurock]

Well, since the sub prime crises and other financial woes, the banks have clamped down hard on credit granting. South Africa has been spared much of the international debt crises as we were not allowed to invest in those risky assets. A new credit act was introduced to reduce and regulate the granting of credit in accordance with the Basel accord.

The Basel accord is as far as I am concerned a damper on business as usual with so many restrictions and rules that it is hard to keep up with all the requirements. By applying the Basel principles, the banks are now expecting the same financial controls and expertise from a mom & pop business as applies to a listed corporate business. This is also an excuse to increase interest rates as the SME is now also rated the same way that Moodys would rate a listed company.

Much of the higher fees and rates was introduced by consulting firms such as McKinsey, which has too many fingers in the pie and are earning commission on showing the banks how to screw their customers.