3 Common Questions About Commercial Mortgages

3 common questions about commercial mortgagesConsidering a building purchase for your business? Here are three common commercial mortgage questions we hear from our clients.

1. Should I purchase a building for my business? 

If you purchase a building and cannot lease 100 percent of it, you are probably entering a completely new business and have limited experience as a lessor, so proceed with caution. If your business expands rapidly or contracts, you could find yourself with a space that is too small or large for your needs, in which case you may be forced to either sell the building or become a lessor.

If you plan to rent the entire building, there are a number of advantages. Every time you make a monthly mortgage payment, your equity increases. If set up properly, you can sell your business and still maintain a monthly rental income from the building. Plus, interest and depreciation on the building are deductible tax expenses and any improvements don’t require approval. Most importantly, the monthly mortgage payment is fixed, whereas rental payments typically increase annually.

2. How are interest rates determined for a commercial mortgage? 

Interest rates for commercial mortgages vary for fixed rate and variable rate loans.  Fixed rate loans are typically 75 to 150 basis points (0.75 percent to 1.50 percent) higher than a 30 year residential mortgage because the loan is not backed by a government entity such as Fannie Mae. Fixed rate loans typically carry a prepayment penalty if the loan is paid off early, since the bank is assuming the interest rate risk.  Many loans are fixed for a certain period of time and then need to be refinanced. For instance, a 7/20 loan would have a fixed rate of interest for seven years but the loan payment would be based on a 20 year amortization. At the end of the seventh year, the borrower either needs to refinance or pay off the mortgage.

Variable rate loans are typically based on LIBOR or the prime rate of interest and will vary based on the loan to value (typically 80 percent or less), the financial stability of the company, and the amount of monthly principal payments the borrower agrees to make. Since the borrower is assuming the interest rate risk, there are typically no prepayment penalties for these types of loans.

In addition to the interest rate, most loans will require the borrower to pay closing costs that include expenses such as an appraisal, an environmental study, legal fees, and application fees.

3. What sorts of covenants and/or conditions are typical? 

Borrowers should be prepared to share tax returns, financial statements, and business plans to the bank on an annual basis. Most loans also have minimum debt service coverage ratios and maximum debt to net worth covenants, and typically require the owners’ personal guarantee.

 

David Shaffer, Kreischer MillerDavid E. Shaffer is a director with Kreischer Miller and a specialist for the Center for Private Company Excellence. Contact him at Email

 

 

 Subscribe to the blog

 

You may also like:

Leave a Reply

Your email address will not be published. Required fields are marked *