THE FINANCIAL INDUSTRY in general (and the major banks in particular) have been under the microscope recently as a result of the Royal Commission. And that has provided a steady stream of negative headlines for the banks over the past 12 months.
As a result, the banks have instituted a number of changes including:
- increased verification of living expenses,
- more conservative servicing calculations, and
- greater oversight of ongoing liabilities.
Unfortunately for property investors, many of these changes have made it harder to borrow to create wealth through property.
So, what do you do if you want to keep investing – but you are not supported by the banks? The good news is that commercial property lending hasn’t been subject to the same regulatory restrictions, as has residential lending.
Sensible income verification tests are still in place.
However, as most good commercial property investments essentially pay for themselves, and this form of borrowing is considered a “business purpose” rather than a consumer loan … lenders do have a measure of flexibility, in establishing your ability to service a mortgage.
So, let’s take a quick look at the various ways available to verify your ability to repay.
For borrowers investing in tenanted commercial property, most lenders will look at an interest coverage ratio on the property itself. This is done by calculating the net income the property generates – as measured against the expected interest payments.
Typically, loans assessed this way can service around a 60-65% Loan to Value Ratio (LVR). But they can sometimes service a higher amount where there is a particularly strong rental return. And loan periods typically fall in line with lease periods.
Where there is sufficient income from a borrower to service the debt from all income sources, a lender may make a full assessment of the borrower’s servicing position.
This type of assessment is more complicated; but the benefits may be a higher lending amount and potentially, a better pricing through a stronger risk rating.
Typically, borrowers will have access to higher funding amounts for borrowing on commercial property, than they would through residential property.
And that’s because the calculations are made on less conservative assumptions; and income from commercial property is generally higher.
Retained or Capitalised Interest
Where a commercial property is untenanted (or if lease income and outside income is insufficient to cover interest), it may be possible to borrow through either prepaying interest for a period, usually 12 months, or capitalising interest.
The latter involves effectively borrowing the interest for the period.
These types of loans are generally not offered by banks. However, there are a wide range of non-banks offering them. Higher interest rates generally apply – so they should be looked on as shorter term solutions.
Bottom Line: Provided the equity is there and the security is acceptable, you will generally find a way to borrow on commercial property.
Therefore, if you are a serious property investor, and your bank says no to any more lending … you should make sure you are aware of all of your options. It may be there are other opportunities just around the corner.