Most forms of commercial funding are not regulated by the Financial Conduct Authority (FCA), who insists that regulated products are strictly underwritten on the basis of income and affordability. This means that, as someone borrowing capital to fund the purchase of commercial premises, you can often borrow more than you could for a residential mortgage.
This is not to say that your funding application will be a simple box-check! Your commercial mortgage or bridging lender will require you to evidence your business accounts, credit history, assets and liabilities, income and expenditure and relevant sector experience, among other things.
The distinction is that how much you can borrow is not usually determined by your own earnings, but by the earning potential of the property you hope to finance.
Debt-service coverage ratio (DSCR)
This brings us to the first factor that will determine how much you can borrow: debt coverage.
Debt-service coverage ratio, or DSCR, is a term used in corporate and commercial finance to determine whether a business’s cash flow can cover its debt repayments.
Commercial lenders in the UK typically use the potential rental income of a property to calculate DSCR. The lender will determine this by arranging a rental valuation. Hence, a far more common term for DSCR in this industry is ‘rental cover’.
By how much your potential income will need to cover your repayments varies depending on the type of property, your intentions for it, and, indeed, the lender’s own criteria. A high-street lender might require rental coverage as high as 190% for commercial properties, and 130% for buy-to-let properties; however, there are lenders who accept lower figures (between 110 and 125%). Working with a specialist broker will give you access to a wide range of options when it comes to lender criteria.
Furthermore, the interest rate used to calculate the debt won’t always be the rate of the product you are applying for. Often, it will be a nominal rate that is in excess of this.
Example: You are taking out a commercial mortgage worth £1.5 million. Rental cover is set at 125%, and even though the interest rate is only 5.75%, the lender uses a ‘stress rate’ of 6.5% in its calculations.
At this rate, your monthly interest repayments would be £8,125, meaning the monthly rent would need to be at least £10,156.25 in order for your lender to agree to the mortgage:
- 1,500,000 × 0.065 = 97,500
- 97,500 ÷ 12 = 8,125
- 8,125 × 1.25 = 10,156.25
DSCR if you are an owner-occupier
If you are buying a property to run a business from yourself, rather than rent out, then a lender will usually work out the debt cover using your ‘adjusted net profit’. This is your net profit with a number of costs added back into it, such as amortisation, depreciation, interest and taxes. Adjusted net profit is used as a broad indicator of a company’s profitability and ability to service debt.
Loan-to-value (LTV) ratio
The other factor that determines how much you can borrow is the value of your commercial property. The loan principal over the asset value gives the loan-to-value, or LTV, ratio.
LTV is capped so that you don’t have too high a debt secured against your property. This limits your lender’s risk, as they are more likely to recoup the full cost of the loan if they need to repossess and sell your property.
Usually, you cannot borrow more than 75% of the property value; however, by offering additional security or borrowing against the market value rather than the purchase cost, you can borrow in excess of this amount.
Increasing your LTV beyond 75%
The simplest way to increase your LTV above 75% is to offer additional security for the loan. This will usually take the form of equity in other commercial properties that you own. By doing this, it is possible to borrow 100% or more of the property value, abrogating the need for a deposit.
If you can’t or don’t want to offer additional loan security, you may also have the option of finding a lender who will lend against the market value or the property, rather than the purchase cost.
The market value refers to the best price you can expect from an independent transaction, assuming that you will have had enough time to market the property and prepare it for a sale. A market value can either be unrestricted or restricted to a predefined time period, such as 90 or 180 days.
Both restricted and unrestricted market values tend to be higher than the purchase price, particularly where the property requires some refurbishment. As such, you are more likely to find a lender willing to lend against a property’s market value if you are applying for a refurbishment mortgage or bridging loan.
For help determining the best finance product and investment strategy, always be sure to speak to a professional commercial finance advisor.
Your property may be repossessed if you do not keep up repayments on any debt secured against it.
The FCA does not regulate some forms of commercial mortgage and bridging loan.
Commercial Trust charges a £995 fee for its buy-to-let mortgage service and the greater of £995 or 1% of the loan value for its bridging loan and commercial mortgage service. This fee is payable only on completion.