You need more space to grow your business. Whether you are starting up or scaling, a nagging question won’t go away: rent or own? Even if you can’t outright buy space with the cash you have on hand, ownership might be a possibility.
A business mortgage might help your business move towards property ownership through monthly payments.
What is a business mortgage loan?
A business mortgage is similar to a home mortgage. Sometimes referred to as a commercial mortgage or a business mortgage loan, a business mortgage is a mortgage or loan on commercial real estate.
Commercial real estate is any property that generates income. You don’t have to be in the commercial real estate business to generate income. If you run a business with the intent to generate income, regardless of your business type, the property where you operate the business is likely commercial real estate.
Sure, if you run your business out of your house, some unique rules apply. But generally speaking, your place of business counts as commercial real estate.
What are business mortgages used for?
Business owners take on business mortgages for two primary reasons:
- To buy commercial real estate
- To renovate commercial real estate
Just like you need a place to live, your business needs a place to operate. If you are like most businesses, you don’t have freely available cash to buy an entire piece of commercial property, or you don’t want to spend all of your free cash on a building for your business.
In either case, a business mortgage allows you to take out a loan from a bank and pay for the property through monthly payments.
The commercial real estate that you buy or renovate with the proceeds from the loan secure the loan. In other words, if you default on the loan (i.e. you stop making payments), the lender bank can foreclose on the commercial real estate that secures the loan.
At a high level, business mortgages don’t differ much from personal or residential mortgages. However, you should be aware of some significant differences before shopping for a commercial mortgage.
Requirements and qualifications to secure a business mortgage?
If you have ever purchased a house, you’ve likely heard of the 20% rule. If your down payment is 20% or greater of the purchase price, you can avoid paying private mortgage insurance (PMI).
That being said, 20% is rarely required to secure a private mortgage on a residential property. Aggressive lending and government programs have enabled families to secure mortgages with no down payment at all, in some circumstances.
Don’t expect to find this flexibility when shopping for a commercial real estate loan.
If you research business mortgage down payment ranges, you will find that most lenders require between 15% and 35% down payments for commercial real estate loans. Small businesses are considered riskier debtors to banks and lenders, and should be prepared to pay on the higher end of that range.
The down payment is higher for commercial property loans, and lenders will also require more financial information for your business than they would your home mortgage. Unlike private mortgages, most business mortgages are not backed by the federal government. Accordingly, the lender takes on all risk associated with the loan and wants to know as much about your business as possible before lending your money for commercial property.
First, the lender wants a good credit score from you and/or your business. Lenders vary on their requirements, but a minimum credit score of 600 is a good rule of thumb when looking to land a business mortgage.
Second, the lender will want to see your business history from both a financial and an operational perspective.
Financially, you will need to produce income statements for at least the last three years. Some banks will require five to seven years of income statements, largely dependent on the size of the loan.
Operationally, you will need to show a history of your business as it relates to the commercial real estate being financed. In other words, if you are taking out a business mortgage for studio space, the bank will want to see what kind of money your studio has made in the years leading up to the loan.
If you need to expand your auto service shop through a business mortgage, the lender will want to see financials related to your ability to generate revenue and profit from the existing shop.
Not only will healthy historical financials help you receive a commercial real estate loan, a sound business plan showing how you expect to use and grow your business with the new space will help your chances of securing the loan.
Finally, banks will take a look at your liquidity when considering your business for a business mortgage. Liquidity is the cash you have on hand, or the assets you have on hand that can easily be turned into cash. The bank wants to make sure you have money readily available to make monthly payments on the business mortgage.
Regardless of whether you have purchased a home, you’ve likely heard of the 30 year mortgage. That’s the standard for personal home loans. In the commercial real estate world, terms are much shorter.
Business mortgage terms fall into two categories from a term perspective.
Short-term business mortgages include terms between two and five years. Long-term business mortgages include terms between five and twenty years.
Because the terms are shorter, lenders typically count on businesses paying on their loan for the entire term. Accordingly, unlike many residential loans, most business mortgages include early pay penalties. Keep this in mind when deciding between a short term and long term business mortgage.
Interest rates and payments
Don’t take the average range at face value.
Commercial real estate loan interest rates vary dramatically depending on the individual business and other risk factors. Age of the business, credit score term, type of business, financial health, location, and other factors could drive your interest rate to 10% or more. You won’t know for sure what type of interest rate to expect until you start conversations with lenders.
Interest rates aren’t the only financial factor to consider when considering business mortgages. Unlike the massive transition to fixed rate mortgages for residential homes after the last financial crisis, many business mortgages include a balloon payment.
A balloon payment is a larger payment due at the end of a loan term that is disproportionately larger than the monthly payments due throughout the term of the loan. Many businesses aren’t concerned with the balloon payment because they plan on paying off the loan early (including the penalty) or they plan on selling the property to another buyer before the end of the loan term.
In these cases, the balloon payment is not a deterrent to taking out a commercial real estate loan. However, if you are not prepared for a balloon payment, it could take your business by surprise and leave you with a large, unanticipated loan payment that could leave your business financially exposed.
Business mortgages function similarly to home mortgages, but you need to be aware of the critical differences that make them more difficult to secure, more expensive, and potentially riskier. With differences identified, is a business mortgage right for your business?
Is a commercial mortgage right for your business?
Can you afford it?
Your business’ ability to afford a commercial real estate loan must be top of mind when considering a business mortgage.
The three expense factors include the interest rate, term, and balloon payment.
Don’t forget about your business growth when considering these expenses. You are considering a business mortgage because you expect to grow. What will your business look like in two years, five years, twenty years?
Consider your future business expectations when considering what’s affordable to your business. That balloon payment may be impossible in two years, but a nonissue in five years.
What term is the right fit?
What other factors will impact your business in the next two, five, and twenty years?
If you are still growing in five years, will your current space physically hold your employees and operations? If not, you may never be faced with a balloon payment. When you get ready to move, you can factor in the balloon payment into the selling price of your commercial property.
What role do you want commercial real estate to play in your business?
There are many businesses, of massive financial strength, that want no business in commercial real estate. Accordingly, they lease hundreds, even thousands of properties around the world.
That might not make any sense from a monthly expense perspective; but then again, owning can be expensive too. Keeping up with maintenance, local ordinances, and other commercial real estate headaches can be distracting to your core business.
Consider the burdens that come along with owning commercial real estate, and the time and resources required to keep up with your property when considering whether your business should lease or own.
Can you get a commercial mortgage? Types for small businesses
Business mortgages are riskier than home mortgages for the lenders. In fact, you might have a harder time securing a commercial real estate loan than you would a home mortgage. Most businesses start with private banks in the business mortgage search, and you might consider that same route.
In the event that private banks are unwilling to lend you money for your commercial property, don’t give up hope.
The Small Business Administration runs multiple programs to help small business owners acquire commercial mortgages.
The SBA 7(a) loan program provides financial assistance to small businesses. SBA 7(a) loans are capped at $5 million for the standard program, and $350,000 for the small loan program. SBA 7(a) loans can be used for commercial real estate, or other business purposes and complete qualification requirements can be found at the program site.
The SBA 504 loan program provides financial assistance to small businesses specifically “to acquire fixed assets for expansion or modernization.” The SBA works with Certified Development Companies (CDC) around the US to facilitate 504 loans.
CDCs are regulated by the SBA and charged with promoting economic development in their local communities. 504 loans are typically structured with the SBA providing 40% of the project cost, a partner lender providing 50% of the cost, and the borrower providing 10% of the project cost.
In the event that you can’t secure a business mortgage with a traditional bank, don’t forget about government-backed alternatives, especially those specifically designed for small businesses.
Commercial mortgages benefit businesses of all sizes and industries
Business mortgages can be a great way for your business to add valuable assets that the business can benefit from now and in the future. While business mortgages are similar to residential mortgages, they include key differences that you need to be aware of before jumping into loans for your commercial property.
Luckily, commercial mortgage loan rates are historically low at the moment, and more and more options are available for small businesses that may not have been able to secure such loans in the past.