Understanding Why Commercial Property Loan Terms are Shorter than Residential Loans
Commercial property loans carry additional complexities to residential property loans. Understanding these and knowing how to navigate them can provide confidence in the decisions required to move ahead with a commercial or industrial property purchase. Here we cover the reasons behind the length of loan terms and why they are often shorter for a commercial property than a residential property loan.
Why are commercial property loan terms shorter than residential loans?
Commercial loans and residential loans are quite different – and one factor that sets them apart is loan term. Commercial loans typically have shorter loan terms. Residential loans on the other hand are more likely to be longer with structured monthly payments. Here are some of the reasons why commercial loans have shorter loan terms.
Market Sensitivity & Risk
Commercial properties are more sensitive to market and economic shifts compared to residential properties. Supply and demand imbalances, economic performance, and business climate can place pressure on certain asset classes, leading to more rapid changes in property values.
This volatility makes longer-term financing riskier for lenders. To counteract this, lenders will offer shorter loan terms to manage potential fluctuations in value and repayment abilities.
A bank lender will typically add annual review covenants for their commercial loans, especially if they’re interest only. These covenants could look at key metrics such as a desktop valuation (a valuation using property data, and comparable sales and listings), leverage review, and interest coverage ratios.
If you’re using a trading entity to service the loan, the lender will often investigate the annual returns of those entities during the annual review process.
Aligning with Lease Terms
For investment properties, the importance of aligning loan terms with tenant lease terms is key. This is because the income for loan repayments is only assured for the duration of these leases. Leases ending without loan renewals create risks for lenders and therefore borrowers. Properties with a longer Weighted Average Lease Expiry (WALE) may attract more favourable financing terms. According to finance brokerage Stamford Capital, the best time to renew your financing is after a lease has been signed.
“Presenting your property in the best light will help you get the best terms – this means the best time to compart the finance market if you hold debt on your property is directly after your new lease, or lease renewal,” says Stamford Capital Senior Associate, Peter Cassar.
“The security of a new lease is attractive to lenders and will streamline the process of evaluating whether your current debt structure is the best for your scenario.”
Shorter loan terms can also work in your favour. It gives you the freedom to refinance and make decisions based on what’s happening in market. A good finance broker will keep track of your loan commitments and advise you on the best course of action for refinancing your loans.
Speak with your Commercial Collective team member who can assist in putting you into contact with a Stamford Capital broker for a finance assessment on your current property portfolio or for any commercial or industrial property you are interested in purchasing.
