IN COMPARISON to the residential market, lending applications for commercial investment loans require a far greater scrutiny on the reliability of income from the property itself, often more so than that placed on the actual borrower.
As a result, it’s useful to understand some of the major factors relating to properties being used as security, which are taken into account by banks when assessing applications.
It’s well known that serviceability is a key component of credit assessment, but there are many other criteria and the below outlines some of the important areas that are looked at.
WALE (Weighted Average Lease Expiry)
When lending on commercial property, banks typically look at the expiry dates on existing leases.
In the event that there are multiple tenancies or leases, they look at the average lease term weighted by rental amount, a figure that is commonly referred to as the WALE.
The major banks generally prefer the loan term to be within the WALE period with a buffer of at least 6 months.
Smaller banks and non-bank lenders will typically just look for a period of at least two years remaining on the lease.
Shorter lease periods may be looked at case by case; but there generally needs to be either outside income or added confidence around the tenant or property. The shorter the WALE period, the higher the risk perceived by the lender, as the vacancy risk is considered higher.
Quality of Tenant
Generally speaking, the importance of who the tenant is increases with borrowing amount for larger transactions. These larger transactions require more scrutiny over who the tenant is and may even require fairly detailed information regarding the solvency of the tenant.
For transactions under $1 million, there isn’t a great deal of assessment of the tenant by the bank, although it is advisable to make your own enquiries.
However, as loan amounts get larger, more importance will be put on who the tenant is; and how long they have been occupying the premises.
Tenants who have been in the property for a reasonable period of time are considered lower risk than completely new tenants.
The main things to look for in the lease terms (in addition to the expiry date) are the expenses the tenant is liable for.
It is generally preferable to the lender that the tenant is responsible for all outgoings, as this provides some certainty with regard to the income amount.
If this isn’t the case, there may be a need for historical accounts and cashflow projections to be provided, making the application far more complicated.
Lenders will also look for a reasonable security deposit or bank guarantee being given by the tenant – so they have something to lose, if they break the lease.
Business Type Implications
While generally most trading businesses are acceptable, certain industries will be considered higher risk than others.
For example: Tattoo parlours, adult shops, gun shops and the like … are considered high-risk by some banks and they are reluctant to lend against them, even if the tenants themselves are stable.
Bottom Line: If you are purchasing a property with a tenant in a category of possible concern, it’s worth getting this looked at upfront.
Paying attention to the above factors will go a long way to ensuring there are no surprises during the loan application.