Often business owners aspire to own the property that they run their business from or have an opportunity to purchase a trading business with a freehold. This is often a first step for these business owners into owning commercial property. Peter Barnes, Consultant Mortgage Broker, talks through the basics of commercial mortgages for owner occupiers and provides an insight into how to secure the right finance for your business.
What is a commercial owner occupier?
A commercial owner occupier is where the individual running the business owns the building and operates their own trading company from this premises.
There are several situations where a commercial owner occupier may need finance:
- The client may be purchasing a ‘trading business’ and a freehold for the first time.
- The client may be purchasing new freehold premises for their existing business to operate from,
- The client may be expanding their business empire by purchasing new property into a group, or,
- The client may be re-mortgaging their commercial property from their existing lender.
- The client could be purchasing mixed use commercial property and living in a residential part above the commercial element, or,
- The client may be purchasing a mixed-use commercial property, trading from the commercial premises and renting out any residential parts above the property.
The basics of commercial owner occupier borrowing
Let’s start with who can take out the mortgage. Commercial owner occupier mortgages are available for individuals (sole traders), partnerships, limited companies or limited liability partnerships.
What about the business itself? Business mortgages can be arranged for most standard business types. Funding can also be arranged on niche propositions including holiday lets, hotels and guest houses, health clubs, pubs and restaurants, schools and care homes.
Often, when clients have the option of purchasing the freehold of the property they trade from, I get asked the same question time and time again ‘How much can I borrow?’ There are a number of ways we can arrive at the final borrowing amount, based on business profitability, leverage (multipliers of the reconstituted net profit – see definitions further down), lending against goodwill of a business (goodwill is the assumed value given to a trading business based on its attractive force that generates its sales) and the ability to lend with supporting security in lieu of cash deposit. Whilst this may seem complicated, an experienced mortgage broker will help you put together all the information required to understand the total value of borrowing that you can achieve. Each lender will have its own policy guidelines, however, our expertise allows us to assess each case on its own merits and source an appropriate lender accordingly.
What ‘income’ do the lenders consider?
Traditionally lenders will assess the maximum levels of borrowing based upon the financial strength of the trading business, i.e. an affordability calculation, coupled with (but not always dependent on) the value of the supporting security provided by the property itself and any other property offered to support the application.
Lenders will analyse the trading accounts, normally the previous 3 years, up to date Management Information (profit and loss since the last year end) and VAT returns. An assessment is made, and they will then calculate the Adjusted net profit / Earnings before interest, depreciation, and amortisation (EBITDA – see below).
Business sales agents usually term EBITDA as the adjusted or reconstituted net profits. This figure forms the benchmark for the assessment of the serviceability of the loan and is therefore integral in determining how much can be borrowed.
On the assumption that the loan is affordable, lenders may advance between 60-75% of the freehold value plus an element of the goodwill. This calculation ranges between guidelines of 5 – 7 times the adjusted net profit after drawings (personal drawings is the withdrawing of cash or assets from the business, by the owner), should a leverage evaluation be included in the lender’s overall appraisal. The specialist lenders that we work with can lend more, 11 to 13 times EBITDA, albeit their lending is primarily based on a percentage of the freehold value, rather than a percentage of the ‘going concern’ valuation.
The lenders will always assess the clients personal drawing requirements by looking at bank statements, and a detailed personal income and expenditure statement. If the clients were selling their house and living above the business premises, then their personal expenses could fall significantly and the business could cover some of those personal expenses. For example, they now have no mortgage to pay and the business would cover certain costs such as electric and gas, or car expenses. We term this as a ‘future income and expenditure’ statement.
How do I calculate what I could borrow?
As the amount you are able to borrow varies from business to business, let’s look at an example.
A hotelier running a leasehold operation has been offered the chance to purchase the freehold from the landlords for £500,000.
With a turnover of £400,000, the accounts show a net profit figure before tax of £80,000. The accounts show depreciation of £5,000, Director’s remuneration of £12,000 and an annual rent of £30,000 (which will cease once the hotelier purchases the property).
The figures are added back to make an adjusted net profit, in this case for example: £80k + £5k + £12k + £30k = £127,000 adjusted net, representing 32% adjusted net profits.
The client’s personal expenditure, per annum, was calculated using a personal expenditure pro-forma, which added up to £30,000. For the lenders purposes this figure is subtracted from the adjusted net profit of £127,000, leaving £97,000 to meet the mortgage repayments.
As already mentioned, the majority of lenders can lend between 60% and 75% of the freehold purchase price or going concern valuation. If the lender is using the freehold purchase price, the amount borrowed can be increased if additional security is offered.
The value the going concern/goodwill of a business is assessed by a commercial valuer. A rule of thumb is that the multipliers can be between 4 and 12 times the adjusted net profits of the business. Being a reputable mortgage broker, Mortgages for Business have a good idea of the multipliers used by the various lenders and using us as a broker, is by far the best way to ensure that you get the best deal for your individual business.
An example mortgage loan
In the example above, £127,000 adjusted net profit with a 6.5 multiple, makes the going concern business worth a staggering £825,000.
The maximum borrowing could be as much as £495,000, in other words almost enough borrowing to cover the purchase of the freehold at £500,000!
The term of the loan would be between 15 and 25 years.
Monthly payments for £495,000 would range between £2475 and £3539 per month.
Interest only mortgage
If the client was looking for an interest only facility from the challenger banks he would need to be prepared to put in a cash deposit of £125,000 which equates to 25%.
The loan would therefore be £375,000.
The interest only payments could be around the 5.08% mark or £1587.50 per month.
What is the maximum LTV I could achieve?
Lenders can lend up to 80% of the business, particularly if this is a preferred sector of the bank’s policy.
If the business’s profitability is exceptional and the client has the right levels of experience, the banks could lend up to 100% of the purchase, by taking additional tangible security. For example, a second charge over the clients private dwelling or maybe a second legal charge over an investment property.
What sort of rates are expected?
Rates are lower for the banks’ favoured sectors (usually those in the ‘professional’ categories), for example a doctor’s surgery, dentist surgery, accountant’s office, pharmacist or solicitor - with rates increasing for businesses in those sectors considered more ‘volatile’ which include retail and leisure for example shops, pubs & restaurants.
The rates for an owner occupier mortgage can be as low as 2% over the Bank of England base rate. Fixed rates are available with premiums between 0.20% and 1% over the variable rate.
What documents are required?
Typically, we will need (for an existing trading business):
- A mortgage application
- Copies of 6 months of personal and business bank statements
- The last 3 years of accounts and management information
- The last 4 VAT returns
- An application fee of £499
There are lenders that will consider advancing to start ups, however, criteria is often at the lower ends of the values detailed above in terms of loan to value of a property and a more robust evaluation of the projected sales figures. In addition to the above (excluding business bank statements and VAT returns) we will need:
- A full business plan which contains information to support the assumptions made within the document
- 3 years projected profit and loss figures
- At least 12 months cash flow forecast
Leave the rest to us!
How quickly can I receive the formal loan offer or lending sanction?
You can expect to receive it within 2 weeks!
Here at Mortgages for Business we will scour the market for the very best deal. Commercial rates are negotiable and we will use our experience and buying power.
A 0.50% reduction on £500,000 = savings of £2,500 per annum. That is a lot of saving over a 15-year term!
Things to watch out for
Is there VAT on the purchase? Is there an asbestos survey in place? Does property the need a structural survey? Will the bank provide committed facilities for the term (i.e. 15 years) or committed funds for a short term, for example 5 years? Does the lender require you have your main business banking with the bank?
How to apply!
If you would like to discuss a commercial owner occupier mortgage, or any type of commercial mortgage, please give me a call on 01732 471641 or email me directly on firstname.lastname@example.org
I promise you, we know our stuff and you will be pleasantly surprised.