Many entrepreneurs aspire to own the property they run their business from, or to have the opportunity to purchase a trading business with a freehold. For first-time commercial investors, our latest blog talks through the basics of commercial mortgages for owner-occupiers, providing 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 premises from which they operate their trading company.
There are several situations where a commercial owner-occupier may need property finance:
- Purchasing a ‘trading business’ and a freehold for the first time
- Purchasing new freehold premises for an existing business to operate from
- Expanding a business empire by purchasing new property into a group
- Re-mortgaging a commercial property from the existing lender
- Purchasing a mixed-use commercial property where the borrower lives in a residential part above the commercial element
- 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
Commercial owner-occupier mortgages are available for individuals (sole traders), partnerships, limited companies, or limited liability partnerships (LLPs).
Commercial 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.
Several factors will impact how much you can borrow, including business profitability, leverage (multipliers of the reconstituted net profit – see definitions further down), lending against the 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 navigate each lender’s individual criteria and guidelines, and get all the necessary information in place for you to make an informed investment decision.
What ‘income’ do the lenders consider?
Typically, lenders will assess the maximum borrowing levels based upon the trading business’ financial strength. This will involve 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 usually analyse the past three years’ trading accounts, 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, also known as EBITDA.
Business sales agents define EBITDA as the adjusted or reconstituted net profits. This figure forms the benchmark for the assessment of the serviceability of the loan. It 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 five to seven 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 we work with can lend more, sometimes 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 borrower’s personal drawing requirements by looking at bank statements, and a detailed personal income and expenditure statement. If you were selling your house and living above the business premises, your personal expenses could fall significantly, and the business could cover some of those personal expenses. For example, you now have no mortgage to pay, and the business would cover certain costs such as electric, 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 depending on the business and the application, it can be helpful to use an example to understand how the calculation will work.
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 personal expenditure, per annum, was calculated using a personal expenditure pro-forma, which added up to £30,000. For the lender’s 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 uses the freehold purchase price, the amount borrowed can be increased if additional security is offered. A commercial valuer will assess the business and use the rule of thumb that the multipliers can be between four and twelve times the adjusted net profits of the 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, which is 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 £2,475 and £3,539 per month.
Interest only mortgage
If you were looking for an interest-only facility from the challenger banks, you 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 £1,587.50 per month.
What is the maximum LTV I could achieve?
Lenders can offer up to 80% of the property value, particularly if this is a preferred sector of the bank’s policy. If the business’s profitability is exceptional and you have the right level of experience, the banks could lend up to 100% of the purchase by taking additional tangible security. This could be in the form of a second charge over your private dwelling or maybe a second legal charge over an investment property.
What sort of rates are expected?
Rates are lower for banks’ favoured sectors, which are usually those in the ‘professional’ categories, for example, a doctor’s surgery, dental surgery, pharmacist, and accountant’s or solicitor’s office. You can typically see rates increasing for businesses in those sectors considered more ‘volatile’, such as 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 (BBR). Fixed rates are now available with premiums much higher than the variable rates, as we see BBR continue to rise, causing rates to change on a weekly basis. If you were looking to fix, we would approach the lender for their quotes at the time of application.
What documents are required?
Typically, for an existing trading business we will need:
- A mortgage application
- Copies of six months of personal and business bank statements
- The last three years of accounts and management information
- The last four VAT returns
- An application fee of £499
There are lenders that will consider advancing to start-ups; however, criteria is often tougher, offering a higher loan to value 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
- Three years projected profit and loss figures
- At least 12 months cash flow forecast
How quickly can I receive the formal loan offer or lending sanction?
You can expect to receive an agreement that the lender will look to fund the deal (subject to full credit assessment) within a week. A formal offer will usually be issued after the business/property valuation has been undertaken by the lender.
Here at Mortgages for Business, we scour the market for the very best deal. Commercial rates are negotiable, and we will use our experience and buying power. For example, if we were to negotiate a 0.50% reduction on £500,000, you would save £2,500 per annum. That is a lot of saving over a 15-year term!
Things to watch out for
Some things to bear in mind when it comes to an owner-occupier purchase include:
- Is there VAT on the purchase?
- Is there an asbestos survey in place?
- Does the property 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, five years?
- Does the lender require you have your main business banking with the bank?
How to start your owner-occupier investment journey
If you would like to discuss a commercial owner-occupier mortgage, or any type of commercial mortgage, please give us a call on 0345 345 6788, or submit an enquiry here.
27th July 2022